All About Inflation

Club of Economics and Finance

IIT (BHU) , Varanasi

Synopsis
Definition
Indicators of Inflation
Types of Inflation
Theories of Inflation
Effects of Inflation
Control of Inflation

Definition
Inflation is the rate at which
the general level of prices for
goods and services is rising
and, consequently,
thepurchasing powerof
currency is falling
Single jump in price levels but
not continuous rise, does not
account for inflation
If inflation is present, the
prices of almost all goods and
services are increasing

Indicators of Inflation
Inflation
rate is the percentage change in the price level,

typically compared to prior year

If the price level in the current year is P1 & in the previous
year is Po, then inflation for the current year is

Rate of inflation is calculated by using a price index as a

proxy for price level
CPI (Consumer Price Index) is the best-known indicator of
Indias inflation

 The CPI basket of India represents the

purchasing pattern of a typical Indian household

The CPI level is given by

CPI =

Types of Inflation
Inflation rate that accelerates out of control is
referred to as Hyperinflation, which can destroy
countrys monetary system
A decreasing trend of inflation rate but still
greater than zero is termed as Disinflation. It
brings down inflationary trend in prices without
causing unemployment
Reflation is a moderate degree of inflation that is
deliberately undertaken to relieve depression

 Deflation is a condition of falling prices on

account of insufficient effective demand
(negative inflation rates) commonly associated
with deep recessions
Stagflation is a situation in which a high rate of
inflation prevails simultaneously with a high rate
of unemployment or stagnant economic
condition. It is a combination of inflation &
stagnation

Theories of Inflation
There are two theories of inflation as follows
I.

Cost-push inflation : Decrease in aggregate

supply

II. Demand-pull inflation : Increase in aggregate

demand

1. Cost-Push Inflation

GDP 1

Contd
Inflation can result from an initial decrease in
aggregate supply caused by an increase in the real
prices of important factors of production
The reduction from SASo to SAS1 increases the price
level from a to b with no initial change in
aggregate demand, reduces output to GDP 1
Decline in GDP that brings a policy response that
stimulates aggregate demand (from ADo to AD2)so
output returns to its long-run potential, there
would be further increase in price

2. Demand-Pull Inflation

GDP 1

Contd
Inflation results due to increase in aggregate
demand caused by increase in money supply,
increased government spending, etc.
Increase in aggregate demand from AD0 to AD1, the
output increases to GDP1 with subsequent increase
in price level from a to b
The increase in GDP above full-employment level is
not sustainable which results in decrease in supply
( SAS0 to SAS1), thus price level increases further to
c

Effects of Inflation
Unanticipated inflation, inflation that is not expected, will
redistribute income and wealth
Unanticipated inflation benefits government because
government is a large debtor
Unanticipated inflation can cause net exports to fall
As the inflation rate increases and becomes more
variable, more resources may be devoted to predicting
inflation and fewer devoted to the production of goods
and services
As the inflation rate increases and becomes more
variable, firms may concentrate on short-term projects
rather than long-term projects

Control of inflation
Monetary policy tools
a) Policy rate
b) Reserve requirements
c) Open Market operations
) Fiscal policy tools
a) Spending tools
b)Revenue tools

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