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Essay on Inflation: Meaning, Features, Types, Causes Effects and Control!
Essay on the Meaning and Features of Inflation:
Inflation means a state of general rise in prices. It covers several economic and monetary aspects, so it needs to be understood clearly. Inflation is commonly understood as a situation in which prices of goods and services constantly rise at a fast pace. Here inflation implies to a state of rising prices and not a state of high prices.
To understand it better we should understand the following concepts first:
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Value of Money:
Refers to the purchasing power of money or its buying capacity, i.e., the number of goods or services which a unit of money can buy.
Relationship between Value of Money and Price Level:
Money is used as a unit of account and a measure of value of all other things, thus its own value can be seen in reference to the price of things.
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The higher the price level, the smaller is the power of money to purchase and thus the value of money would be lower and with the lower price level the purchasing power would increase along with the increase in the value of money.
Symbolically Vm = 1/P
Where, Vm = Value of money,
P = Price level
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Thus, Vm is inversely proportional to P.
For example-
Selling price of sugar = 0.20 per kg
Unit of money, i.e., one rupee can buy 5 kg of sugar
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so, Vm = 5 kg.
If the price falls to Rs. 0.10 per kg, value of money will be increased to 10 kg.
so, Vm = 10 kg.
Here we find a change in value of money but good money is the one whose value remains stable. If the changes in value of money occur, it may cause harmful effects of inflation and deflation. Inflation implies to declining value of money and deflation implies to rising value of money.
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Definitions:
Inflation can be defined as following:
“As a state in which the value of money is falling, i.e., prices are rising.” -PROF. CROWTHER
Here it must be understood that all price rise is not inflation. In this context PROF. HAWTREY defined inflation as, ‘the issue of too much currency’. But in this definition, the exact meaning of too much currency is not clear. In fact, it should be correlated with some economic condition of the country or economic progress.
“The rise in price level after the point of full employment is true inflation.” -J. M. KEYNES
MARTIN BRON FENBRENNER and FRANKLYN D. HOLZMAN in their famous survey article on ‘Inflation Theory’ have suggested the following alternative definitions of inflation:
“Inflation is a condition of generalized excess demand in which too much money chases too few goods.”
“Inflation is a rise of the money stock or money income, either total or per capita.”
“Inflation is a rise in price levels with additional characteristics or conditions. It is incompletely anticipated; it does not increase employment and real output; it is faster than some safe rate; it arises from the side of money; it is measured by prices net of indirect taxes and subsidies; and or it is irreversible.”
“Inflation is a fall in the external value of money as measured by foreign exchange rates, by the price of gold or indicated by excess demand for gold or foreign exchange at official rates.”
Thus, we can say that every type of price rise cannot be called as inflation.
The important criteria that need to be satisfied for inflation are:
(i) Price rise should be substantial.
(ii) Price rise should be constant and at a fast rate (one time rise does not refer to inflation).
(iii) Price rise should be for a larger period of time.
(iv) Price rise should be of many goods and services simultaneously.
Essay on the Features of Inflation:
The important characteristics of inflation may be summarized as under:
1. Inflation is always associated with a rise in prices which is continuous and persistent. It should be distinguished from price rise which may occur temporarily or during a cyclical upswing.
2. Inflation is a dynamic process which can be observed over the long period.
3. Inflation is basically an economic phenomenon. It originates within the economic system and is fostered by interaction of economic forces.
4. Excess of demand over the available supply is the hall mark of inflation. It is a condition of economic disequilibrium.
5. Inflation is generally considered a monetary phenomenon for it is normally characterized by an excessive money supply. Though all increases in the stock of money may not be inflationary yet a persistent rise in prices cannot be sustained unless the quantity of money rises as well.
6. Inflation may be caused by ‘demand-pull’ factors or ‘cost push’ factors or both working together.
7. Inflation is always cumulative in the sense that a mild inflation in the first instance gathers momentum leading to rapid price rises. Its effects on an economy depends on how rapid it is.
Types of Inflation:
1. Creeping Inflation:
‘Creeping inflation occurs when there is a sustained rise in prices over time at a mild rate, say around 2 to 3 percent per year. It is also known as ‘mild inflation’. This type of inflation is not much of a problem.
It is generally known as conducive to economic progress and growth. In this form the prices rise gradually over a long period.
2. Walking or Trotting Inflation:
When the rate of rise in inflation is of international range of 3 to 8 percent per annum, it is called walking or trotting inflation. It is an alarming signal for the government to control it before it worsens.
3. Running Inflation:
When the sustained rise in prices is over 8 percent and generally around 10 percent per annum, it is called running inflation. It normally shows two-digit inflation. Running inflation is a warning signal indicating the need for controlling it. It affects the poor and middle class people adversely.
4. Hyper or Galloping Inflation:
Hyperinflation occurs when monthly increase in prices is 20 percent to 30 percent or more. At this stage there is no limit to price rise, and price rise goes out of control. Money becomes almost worthless causing severe hardship to people. There is complete collapse of currency, the monetary system collapses and the economic and political life gets disrupted.
5. Open Inflation:
Inflation become open when there is no barrier to price rise. It occurs in the economy where there are no control and checks on price rise. Rising prices by large magnitude is the symptom of open inflation.
6. Suppressed Inflation:
Suppressed inflation refers to a situation when there exists inflationary pressures in the economy but prices are controlled by certain administrative measures, such as price-control and rationing. The increase in prices are suppressed (or repressed) here. However, prices rise by large magnitude after the price controls are removed.
The symptoms of suppressed inflation are long queues of buyers at government controlled ration shops and the existence of excess demand and black- markets. The controls ensued by the government on the prices of essential commodities in times of war is an example of suppressed inflation.
Essay on the Explanation of Inflation:
The traditional explanation of inflation runs in terms of forces operating from the demand and supply ends. Inflation originating from the demand forces (demand of goods and services) is commonly referred to as demand pull inflation. On the other hand, inflation originating from the forces operating from the supply side or increase in cost of production is known as cost push inflation.
Demand Pull Inflation:
Demand pull inflation occurs when the demand for goods and services exceeds the supply available at existing prices, i.e., when there is excess demand for goods and services. Aggregate demand refers to the total demand for goods and services in the economy.
Aggregate demand may increase due to increase in consumption expenditure, an increase in investment expenditure or government expenditure or increase in money supply. Through any source if the aggregate demand rises rapidly and exceeds the economy’s production, prices will begin to rise more and more rapidly. The demand for money will beat the limited supply of commodities and will bid up the prices. Excess demand which exceeds the supply available at the existing prices will pull up the price level and will lead to emergence of inflation.
When aggregate demand exceeds aggregate supply at full employment level, the gap between these two {i.e., AD and AS) arises. This gap (which is technically termed as inflationary gap) leads to rise in prices. The larger the gap, the greater will be inflation.
However, there is disagreement among economists over the relative importance of monetary and real factors causing inflationary rise in prices. According to some economists like MILTON FRIEDMAN, inflation is always and everywhere a monetary phenomenon produced by a sharp increase in money supply. Other economists like J. R. HICKS, feel that real factors play a crucial role in producing inflationary rise in prices.
Another explanation of inflation is in terms of forces operating from the supply side or the cost side. It is known as supply or cost theory of inflation, popularly known as cost push inflation. Cost push inflation refers to inflationary rise in prices due to increase in costs. Cost push inflation is caused mainly due to increase in cost of wages and increase in profit margin.
The primary cause of cost push inflation is the rise in money-wages in excess to rise in productivity of labour. Strong trade unions are able to press employer to grant money for wage-rate increase in per unit cost. As a consequence, producers raise their prices to cover the higher cost. A series of increased wage-rates leads to a simultaneous increase in inflation.
Cost push inflation theory is the modern theory of inflation. It is also called as the ‘New Inflation’. This type of inflation emerges due to increase in the costs. Modern economists observe that inflation is also possible in a situation where aggregate demand is failing while cost of production is rising.
Essay on the Causes of Demand Pull Inflation or Demand Pull Factors:
There are two major factors:
(I) Real factors,
(II) Monetary factors
(I) Real Factors:
Include the following sub factors:
1. Increase in Public Expenditure or Increase in Government Deficit- Government deficit increases when the public expenditure increase and the government fails to mobilize sufficient funds to meet its expenditure.
The public sector expenditure during The First Plan was Rs. 1,960 crores which increased to Rs. 2, 20,000 crores during Seventh Plan and to Rs. 23, 68,530 crores during Tenth Plan. This tremendous increase in Government expenditure has led to the increase in demand for goods and services but the availability of these has not increased proportionately and under such conditions, the price rise is natural.
In order to meet this expenditure the government prints new currency. This is called deficit financing. Additional money in the economy leads to a rise of increased demand for goods and services without a corresponding increase in supply of goods and services, thus the general price level goes up. This results in ‘deficit induced inflation’.
In India, the deficit financing was Rs. 330 crores during First Plan, which went up to Rs. 14,000 crores in Seventh Plan and to Rs. 20,000 crores in Eighth Plan. But the supply of goods and services did not increase and ultimately affected the prices of almost all items.
2. Increase in Income:
With the increased income of people, rises the demand for the goods and services and hence their prices.
3. Decrease in Taxes or Hoarding of Black Money:
Black money means unaccounted money. It is created through tax-evasion and is responsible for price-rise. Black money is spent on non-productive activities like buying real estate, gold smuggling, luxurious living, etc. The amount of black money is estimated to be about Rs. 6 lakh crores and Rs. 50,000 crores is added every year. Black money generates hoarding of goods in the economy.
4. Increase in Population:
It is another major cause for rise in prices. Increase in population refers to increased demand of consumer goods which puts a pressure on existing supply of goods and services, thus resulting in inflation.
5. Increase in Export Demand:
Expansion in foreign demand and consequent expansion in exports will raise the incomes of poor people. This will push up demand for goods & services within the country.
6. High Rate of Investment:
The heavy investments made by the Government as well as private industrialists have resulted in continuous increase in the prices of capital goods and other items of production.
(II) Monetary Factors:
This included the following sub factor:
1. Increase in Supply of Money and Change in Real Income:
There has been a great disequilibrium between increase in the supply of money and the increase in real income. In our country, the supply of money has been much greater than the increase in real income (or say output) and this has been the main cause of price rise.
Cheap monetary policy or the policy of credit expansion adopted by the monetary authority also leads to increase in the money supply which raises the demand for goods and services in the economy. When credit expands, it raises the purchasing power of the borrowers which, in turn, raises aggregate demand relative to supply, thereby leading to inflation.
This is also true on the basis of Quantity Theory of Money which states, “The increasing supply of money directly affects the price levels.” Since 1950-51 to 1990-91, the real national income increased by four times only as against the money supply which increased by 46 times. This resulted in the situation of more money chasing less goods.
According to the data, released by the Reserve Bank of India, the money supply (currency + deposit) is Rs. 2, 01,970 crores in 1999-2000, which increased to Rs. 3, 82,357 crores as on 2004-2005. It further increased to Rs. 9, 14,197 crores as on 2010-11.
Similarly, the aggregate money has increased from Rs. 11, 79,853 crores to Rs. 23, 72,095 crores as on 2004-2005, and with a whopping rise, it reached to Rs.64, 99,548 crores as on 2010-11.
Essay on the Causes of Cost Push Inflation or Cost Push Factors:
1. Fluctuations in Output and Supply:
The wide fluctuations in production of food grains have been mainly responsible for price rise. There was a remarkable increase in production of food grains during first two plans and supply of food grains was good. But fluctuation in food grain production, support prices administered by Government, the tactics of hoarding adopted by the middlemen and subsequently by the farmers too (utilizing the credit facilities available from co-operatives and commercial banks) resulted in an increase in price.
The power breakdowns, strikes and lockouts result in lower production of manufactured goods. As such both, the primary and secondary sectors recorded a price rise almost during all the plan periods.
2. Public Distribution System:
The defective working of the public distribution system results in an uneven supply of various goods, ultimately affecting the prices of essential commodities by way of artificial scarcity.
3. Rise in Wages:
The rise in the general price level raises the cost of living which, in turn, leads to demand for higher wages by workers. When the demand for higher wages is met, it leads to further rise in costs or prices. The fresh rise in prices will again be compensated by giving still higher wages to the workers. This is termed as ‘wage push inflation’.
Rise in wages has been considered the main determinant of cost push inflation because in modern times, workers have organized themselves into strong trade unions which have succeeded in getting higher wages for their members. When price rises due to rise in wages, it is called wage inflation.
Wage increases are induced mainly by the following factors in operation:
(i) Excess demand for labour.
(ii) Increase in cost of living.
(iii) Increase in productivity of labour and resultant demand for more than proportionate wages.
(iv) Substantial control over the supply of labour.
4. Increases in Profit Margins:
High profit margins on the part of producers due to their monopolistic position raise the cost of production which in turn pushes up the prices. This kind of inflation is termed as profit induced inflation.
5. Enhanced Taxation:
With every year’s budget, the government imposes fresh commodity taxes. It leads to an increase in prices of different commodities in general which in turn push up all the prices. The railway budget, sales tax, excise duty, etc., directly affect the prices of all types of commodities.
6. Administered Prices:
The prices of cement, steel, coal, fertilizers, etc., are increased regularly by the public sector which also add to rise in costs of different factors of production and cause price rise in general.
7. Oil Price Hike or Rise in International Prices:
Global inflation and hike in oil prices has resulted in higher import of crude oil from abroad. It results in rise in prices of diesel, petrol and other petroleum products in India. This leads to higher transport costs and electricity generation.
8. Inadequate Agricultural Growth:
Slow growth rate of agricultural products and production of agro-based industries is due to inadequate supply of some raw materials. The failures of crops due to drought or other natural calamities leads to the fall in the supply of agricultural products further.
9. Other Factors:
Besides increase in oil prices and increase in administered prices of various items, the excess of foreign exchange has also caused inflation. The R.B.I. Governor, pointed out that a surge in foreign exchange has created a liquidity problem with the increase in cash assets.
Deflation:
A sustained fall in general price level is called deflation. Deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflaton rate falls below 0%. Inflation reduces the real value of money once time. Deflation is distinct from disinflation which is a slowdown in the inflation rate, i.e., when inflation declines to a lower rate but is still positive.
Stagflation:
It is comprised of:
(i) Stagnation; and
(ii) Inflation.
It is a situation in which-
(a) General price level moves upwards than the normal price line.
(b) The economy experiences lack of investments, stagnation in production and growing unemployment.
The import-export policy, devaluation of rupee, and other liberalization measures have also contributed to inflation. The shortfall in domestic production of price-sensitive items like pulses, edible oils, etc., has created an imbalance between demand and supply.
The Government has declared support prices for wheat and other cereals but has failed to procure adequate quantities for arranged distribution which has caused price rise of these commodities.
Essay on the Effects of Inflation:
The main effects of inflation and higher prices in India are discussed below:
During inflation, the producers and businessmen gain in the short-period. Usually the cost of production does not rise as fast as the price of their product and so there is an artificial margin of profit. As against this, they may also be affected adversely in the long run. If the price level goes on increasing, the total consumption of their product would fall.
The reduced consumption will ultimately raise the cost of production per unit and reduce the profits.
1. Misallocation of Resources and Disrupted Price Mechanism:
Inflation disrupts the smoothness of price mechanism. It finally ends in mal-adjustments in production. Producers turn towards more production of luxury goods which are non-essential over essential commodities, from which they expect higher profits.
2. Hoarding:
In times of inflation, people, like traders hoard stocks of essential commodities with an idea to earn more profits in the near future. As a result, the available supply of goods in relation to increasing monetary demand, decreases. This results in black marketing, i.e., artificial scarcity of goods in the market.
3. Encourages Speculation:
A non-anticipated steep rise in prices creates a situation of uncertainty in the economy. People indulge more in speculative activities than in increasing production.
4. Lack of Quality Control:
Inflation tries to create a sellers’ market. Sellers get a command on prices because of excessive demand in the market. In such conditions, the sellers overlook the quality of their goods, instead they concentrate more on earning great profits.
(II) Effect on Distribution of Income:
Inflation redistributes income because prices of all factors do not rise in the same proportion. Here, prices rise faster but incomes do not. There is an inequality in distribution of wealth. During inflation, producers and traders are the gainers. As a result, rich get richer and poor get poorer. It leads to concentration of wealth in the hands of a few rich people.
1. Effect on the Working Class:
Labour is the lowest paid class. This class is badly affected by inflation, especially if the prices of the basic necessities of life rise steeply. It adversely affects the family budget of the working class. Their consumption level goes down tolling upon their health and lowering their efficiency. It may also create unrest.
No doubt, through trade unions, workers may manage to get increased dearness allowance but this does not provide them with desired relief. Price hike generally precedes any increase in dearness allowance. In turn, the increased wages further push up the price level owing to an increased demand. A vicious circle is formed, resulting in wage-push or cost push inflation.
2. Effect on Fixed Income Groups:
This group includes pensioners, government servants, owners of government securities and promissory notes and others who get a fixed money income. They are known as renters. This class is worst affected by inflation because the purchasing power of their fixed income goes on decreasing with rising prices.
3. Effect on Debtors and Creditors:
Debtors gain when they pay back their debt during inflation. It is because the value of money was high when they borrowed but came down when they repaid their debts. As against this, the creditors are losers during inflation. However, if debtors take loans during inflationary period, the position is reversed. In that case, the debtors are losers and the creditors are gainers.
1. Cost Increases:
As prices increase, cost of projects both in private and public sectors goes-up. Consequently, the total outlay of each plan exceeds the one provided as per original plan yet physical targets are not fully achieved.
2. Effect on Economic Development and Reduction in Savings:
Due to rise in prices, economic development of a country has adverse effects on savings and investments.
3. Wage Spiral:
A rapid increase in prices is not suitable as workers demand more wages. Under such circumstances, wages are raised to compensate the workers. Thus, price spiral affects the economy.
4. Effect on Foreign Investment:
A rapid increase in prices has an adverse effect on the foreign investment in the country. Foreign investors do not invest their money in those countries where the value of money is falling on account of rise in prices. Value of money falls and the investors suffer losses.
5. Adverse Balance of Payment:
Price rise has an adverse effect on the export of the country. Exporters fail to increase the exports to the desired extent. Actually, our exportable become relatively expensive in the world market, resulting in the fall of export and our importable become relatively cheaper, this increases our imports.
The demand for country’s exports decreased and imports increased. Therefore, balance of payment continues to be unfavourable.
6. Lack of Confidence in the Currency:
Money stops functioning as money because people lose confidence in currency and do not like to hold it. In 1923, during hyperinflation in Germany people refused to accept ‘Marc’ as their unit of currency. Money was replaced by Barter system because people preferred goods over money.
7. Social and Moral Degradation:
Inflation leads to thefts and robberies because some people would like to get an income in undesirable ways so as to survive. Corruption breeds during inflation and moral ethical values take a down stride.
8. Effect on Political Stability:
Continued inflation results in shaking the foundation of any political system. It even results in the fall of any government.
Essay on – How to Curb (Control) Inflation?
Inflation is harmful for the economy if not checked on time. Primarily there are two categories of measures i.e., monetary measures and Fiscal measures which are to be taken by government to control inflation but there are other measures also which can be taken by government to curb inflation.
They are following:
i. Monetary Measures:
Monetary measures are taken by a country’s Central Bank (Reserve Bank of India in India) on behalf of the government. The monetary measures in detail will be discussed in the next chapter. Monetary measures work through changes in the quantity of money and rates of interest.
For example- Reserve Bank of India or RBI frequently changes the repo rate and reverse repo rate to bring changes in the lending rate of interests of the banking system. The rise in repo rate makes the borrowing from RBI costlier for commercial banks, which makes lending by commercial banks costlier.
So the demand for credit by bank customers falls and so the excess demand. This reduces the inflation. Similarly by increasing Cash Reserve Ratio, Statutory Liquidity Ratio and Margin requirements, the supply of money is reduced and loans are made costlier. This controls the inflation.
ii. Fiscal Measures:
Fiscal measures are taken by the government directly. Fiscal measures work through the government expenditure and tax rates. When the government spends money on various heads’like road and dam construction, subsidies, salaries of ministers and administrative employees and many other heads, etc., it supplies money in the form of incomes.
Thus by reducing expenditure, the government may reduce the supply of money and inflationary pressure. Similarly, by increasing taxes government may also reduce the purchasing power in the hand of the people, hence reducing the inflationary pressure in the economy.
Government may resort to surplus budget in which government incomes are more than government expenditure. Government may also promote the savings in the country. Various schemes like compulsory deposit schemes, national savings schemes, etc., have been introduced to encourage the people to save more.
This will reduce the effective demand of the people and prices will remain under control to some extent.
There are other measures also which can be employed by the government to curb inflation.
They are following:
i. Rationing and Price Control:
The government can introduce rationing system for essential commodities, so as to ensure proper supply. In India a large number of fair price shops have been opened. This enables the poorer sections of the people to purchase the commodities on controlled price.
ii. Increase in Agricultural and Industrial Production:
To induce the farmers to grow more food grains, the government can announce procurement prices for several items. Loans and credits can be granted to improve their lands and to procure good seeds, fertilizers, etc. The increased production would ensure adequate and proper supplies and control the prices within limits.
Moreover, maintenance of buffer stocks also helps in checking the rising prices and in meeting the demand of the people. Similar steps can also be taken for increased industrial production.
iii. Control on Population Growth:
In order to control the demand for consumer goods, it is essential to curb the rapid rise in population. This check is also necessary to reduce the expenditure of the government on housing, civic amenities, public health, education, etc.
iv. Other Measures:
Trade and tariff policies must be modified to make the domestic prices of industrial products, reasonably competitive. Excise duties on several industrial products should be reduced to accelerate the pace of industrial growth.
v. Punishment for Hoarding:
Government must take stringent steps to stop hoarding of essential commodities. For this purpose proper administrative mechanism should be devised and put in place.
vi. Check on Speculation:
Government must control speculation in essential commodities. Though future markets have been organised and online trading of commodities has been allowed by the government but it should be kept in mind that speculation in online trade has contributed significantly in increasing inflation which should be stopped at any cost.
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