INFLATION

 

• INFLATION
  
  
  
• MACRO ECONOMICS
• DR SHASHI AGGARWAL
• NET MANAGEMENT UNIT 1
• MEANING OF INFLATION
• A PERSISTENT RISE IN PRICES IS CALLED INFLATION.
• GREGORY,” INFLATION IS INCREASE IN THE QUANTITY OF PURCHASING POWER
• PETERSON,” THE WORD INFLATION IN THE BROADEST POSSIBLE SENSE REFERS TO ANY INCREASE IN THE GENERAL PRICE LEVEL WHICH IS SUSTAINED AN NON SEASONAL IN CHARACTER
• COULBOURN,” INFLATION IS THE STAGE OF TOO MUCH MONEY CHASING FEW GOODS.
• CAUSES OF INFLATION
• DEMAD PULL INFLATION:-RISE IN PRICE IS MAINLY DUE TO INCREASED DEMAND FOR GOODS. AS THE POPULATION IS GROWING AT RAPID SPEED AND THEY ARE DEMANDING MORE GOODS BUT SUPPLY OF GOODS IS LESS.DEMAND IS RISING BECAUSE OF MORE GROWTH OF POPULATION,RISING DISPOSABLE INCOME,BLACK MONEY,EXPANSION OF MONEY SUPPLY,DEFICIT FINANCING ETC
• COST PUSH INFLATION:-DUE TO RISE IN IN COST OF PRODUCTION DUE TO RISE IN INPUT PRICES,INCREASED WAGES,RISE IN INDIRECT TAXES,HIKE IN OIL PRICES,POOR TECHNOLOGY ETC
• KEYNESIAN VIEW OF INFLATION
• WITH REFERNCE TO THE LEVEL OF EMPLOYMENT
• SEMI –INFLATION : INCREASE IN THE QUANTITY OF MONEY BEFORE FULL EMPLOYMENT LEADS TO INCREASE IN OUTPUT AND EMPLOYMENT. INCREASE IN PRICE LEVEL PRIOR TO FULL EMPLOYMENT IS TERMED AS SEMI INFLATION. DUE TO HINDERANCES IN MOBILITY OF FACTORS OF PRODUCTION. ALSO CALLED BOTTLE NECK INFLATION.
• OPEN OR FULL INFLATION:  INCREASE IN THE QUANTITY OF MONEY AFTER FULL EMPLOYMENT LEADS TO RISE IN THE PRICE – LEVEL WHICH IS CALLED OPEN,FULL TRUE OR ABSOLUTE INFLATION
• THREE MEASURE OF PRICE BEHAVIOUR
• PRICE BEHAVIOUR REFERS TO CHNAGNES IN GENERAL PRICE LEVEL IN THE COUNTRY OVER A PERIOD OF TIME.
• THREE  STANDARD MEASURE OF PRICE BEHAVIOUR

1. WHOLE SALE PRICE INDEX
2. CONSUMER PRICE INDEX
3. GDP DEFLATOR

• WHOLE SALE PRICE INDEX

1. MEASURE THE CHNAGES IN WHOLE SALE PRICE ON WEEKLY BASIS
2. AVERAGE WPI IS WORKED OUT
3. AVERGAE ANNUAL WHOLE SALE PRICES OF THE CURRENT YEAR ARE RELATED TO AVERGAE ANNUAL WHOLE SALE PRICES OF BASE YEAR ( ASSUMED 100)
4. COVERS NEARLY 435 COMMODITIES
5. DOES NOT ACCOUNT FOR THE SERVICES
6. WEIGHTS ARE ACCORDED TO DIFFERENT GOODS DEPENDING ON THEIR RELATIVE SIGNIFICANCE
7. 63.75% WIEGHATGE IS ACCORDED TO MANUFACTURED PRODUCTS
8. 22.03 TO PRIMARY ARTICLES AND 14,23% TO FUEL AND LUBRICANTS

• CONSUMER PRICE INDEX

1. MEASURE THE CHANGES IN RETAIL PRICES ON MONTLY BASIS
2. AVERAGE CPI IS WORKED OUT
3. AVERAGE ANNUAL RETAIL PRICES FOR THE CURRENT YEAR ARE RELATED TO AVERAGE ANNUAL RETAIL PRICES OF THE BASE YEAR ASSUMED TO BE 100
4. LIKE WHOLE SALE PRICE INDEX DIFFERENT GOODS ARE ACCORDED WEIGHTS DEPENDING ON THEIR RELATIVE SIGNIFICANCE
5. INCLUDES BOTH GOODS AND SERVICES
6. FOCUS ON HOMOGENOUS GROUP OF CONSUMERS LIKE INDUSTRIAL WORKERS,AGRICULTURAL LABOURERES
7. REFLECT COST OF LIVING
8. CPI FOR THE INDUSTRIAL WORKER IS WIDELY USED INDEX FOR INDUSTRIAL WORKERS
9. ALSO USED TO CALCULATE DA AOF GOVERNMENT EMPLOYEE
10. CPI IS ALSO CALCULTED FOR AGRICULTURAL LABOUR,CPI FOR URBAN NON MANUFACTURED EMPLOYEE

• GDP DEFLATOR : GDP DEFLATOR= GDP AT CURRENT PRICES/GDP AT CONSTANT PRICES
• GDP DEFLATOR = 1
• IMPLYING NO CHANGE IN PRICE LEVEL
• GDP DEFLATOR IS 2 ,RISE IN PRICE LEVEL BY A FACTOR OF 2 AND GDP DEFLATOR IS FOUND TO BE 4.RISE IN LEVEL OF PRICE BY FACTOR OF 4
• BETTER MEASURE OF PRICE BEHAVIOUR BECAUSE IT COVERS ALL GOODS AND SERVICES PRODUCED IN THE COUNTRY.
• TYPES OF INFLATION
• ON THE BASIS OF DEGREE OF GOVERNMENT CONTROL
• OPEN INFLATION:-REFERS TO A SITUATION AT WHICH NO STEPS ARE TAKEN TO CONTROL RISING PRICES. PRICES ARE ALLOWED TO RISE WITHOUT ANY ATTEMPT ON THE PART OF THE GOVERNEMENT TO CONTROL. GOODS ARE DISTRIBUTED THROUGH PRICE MECHANISM
• SUPRESSED INFLATION:-RISING PRICES ARE CHECKED BY GOVERNMENT BY TAKING ADMINISTRATIVE STEPS LIKE RATIONING,PRICE CONTROL ETC. IT IS DANGEROUS THAN OPEN INFLATION. UNDER SUPPRESSED INFLATION PRICE MECHANISM BECOMES UN OPERATIVE AND BLACK MARKET,CORRUPTION AND RESOURCES ARE INEQUITABLY DISTRIBUTED
• CLASSIFICATION ON THE BASIS OF TIME
• WAR TIME INFLATION:-THAT TAKES PLACE DURING THE COURSE OF WAR. IN OREDER TO MEET WAR EXPENSED GOVERNMENT INCREASE THE SUPPLY OF MONEY. BUT DURING WAR,PRODUCTION IS MORE OF WAR MATERIAL THAN GOODS FOR PUBLIC
• POST WAR INFLATION:-TENDENCY OF INFLATION PERSISTS EVEN AFTER THE WAR MAINLY DUE TO :
• GOVERNMENT HAS TO SPEND LARGE AMONUNT ON REPAIRS AND RECONSTRUCTION OF DAMAGED PROPERTY
• ABOLISHMENT OF TAXES LEVIED DURING WAR AND LOANS ARE REPAID
• PEACE TIME INFLATION:-AS UNDERDEVELOP COUNTRIES REQUIRE HUGE RESOURCES FOR BOOSTING THE DEVELOPMENT PROCESS AND IT LEADS TO DEFICIT FINANCING WHICH IN TURN LEADS TO RISE IN PRICES

 

• ON THE BASIS OF RATE OF INFLATION
• CREEPING INFLATION : SLOW PRICE RISE ( 3% RISE IN PRICE). SUCH AN INFLATION IS NOT BAD FOR THE ECONOMY. ESSENTIAL FOR THE GROWTH OF THE ECONOMY
• WALKING INFLATION : INTENSE AND GAINS MOMENTUM . WHEN OVER A DECADE PRICE RISE BETWEEN 3 TO 8%.IT IS CALLED WALKING INFLATION
• RUNNING OR GALLOPING INFLATION:- RAPID INCREASE IN VERY SHORT PERIOD 8 TO 12%. SUCH INFLATION HAS ADVERSE AFFECT ON MIDDLE AND POOR CLASSES.DISCOURAGES SAVING
• HYPER INFLATION : HYDRA HEADED INFLATION . PRICE RISE AT AN EXPECTED RATE. IT PUTS THE ENTIRE ECONOMY OUT OF GEAR.

 

• RATE OF INFLATION
• DIAGRAM
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• CLASSIFICATION ON THE BASIS OF SCOPE
• SECTORAL SPORADIC INFLATION:-WHEN INFLATION AFFECTS ONLY A PARTICULAR PART OR SECTOR OR COVERS ONE OR TWO GOODS
• COMPREHENSIVE INFLATION: NOT CONFINED TO GIVEN PART OF THE COUNTRY BUT COVERS THE ENTIRE COUNTRY
• ACCORDING TO PROCESS
• WAGE INDUCED INFLATION: POWERFUL LABOUR ORGANIZATION DEMAND HIGHER WAGES AND IT IN RETURN INCREASES THE COST OF GOODS
• PROFIT INDUCED:-BIG COMPANY MAKE CARTELS AND FIX HIGHER PRICES BY ADDING HUGE MARGINS.
• DEFICIT INDUCED:-DUE TO INCREASE IN THE MONEY SUPPY DUE TO DEFICIT FINANCING BUT NO INCREASE IN THE PRODUCTION,
• DEMAND PULL INFLATION:-AGGREGATE DEMAND EXCEED AGGREGATE  SUPPLY OF GOODS AND SERVICES

 

• ACCORDING TO PROCESS:-
• CAUSED DUE TO INCREASE IN THE COST OF PRODUCTION DUE:

1. INCREASE IN THE COST OF RAW MATERIALS
2. INCREASE IN TAXES AND DUTIES
3. INCREASE IN WAGES WITHOUT INCREASE IN PRODUCTIVITY

• INFLATION IN INDIA
• MANY DEVELOPING COUNTRIES USE CHANGES IN THE CONSUMER PRICE INDEX AS THEIR CENTRAL MEASURE OF INFLATION IN INDIA. IN INDIA ALSO USES CHANGES IN THE CPI TO MEASURE INFLATION.
• THE INFLATION RATE IS CALCULATED USING THE PRICE INCREASE OF DEFINED PRODUCT BASKET
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• CAUSES OF INFLATION
• DEMAND SIDE

1. INCREASE IN PUBLIC EXPENDITURE
2. DEFICIT FINANCING
3. CHEAP MONETARY POLICY
4. INCREASE IN DISPOSABLE INCOME
5. BLACK MONEY
6. INCREASE IN INVESTMENT
7. REDUCTION IN TAXES
8. INCREASE IN EXPORTS

• CAUSES OF INFLATION
• INCREASE IN PUBLIC EXPENDITURE :
• LEADS TO INCREASE IN PURCHASING POWER  DUE TO WHICH INCREASE IN MORE DAMAND FOR GOODS AND SERVICES
• AFTER FULL EMPLOYMENT AS THERE IS NO PRODUCTION  PRICE  RISE WILL BE THERE
• DEFICIT FINANCING : LEADS TO INCREASE IN MONETARY INCOME AND DEMAND FOR GOODS INCREASE
• CHEAP MONETARY POLICY : ALSO CASUSES EXCESSIVE INCREASE IN SUPPLY OF MONEY AND INCREASE IN DEMAND FOR GOODS AND SERVICES
• INCREASE IN DISPOSABLE INCOME : INCREASE IN THE INCOME OF COUMSERS. DEMAND FOR GOODS INCEASES DUE TO INCREASE IN CONSUMER’S INCOME. INCREASING PRESSURE ON DEMAND RESULTING IN HIGH PRICES
• BLACK MONEY : UNACCOUNTED MONEY IS CALLED BLACK MONEY. THAT IS SPENT ON LUXRIES AND CONSPICOUS CONSUMPTION
• INCREASE IN INVESTMENT : PROSPECTS OF PROFITS ARE HIGH THEN FIRM INCREASE INVESTMENT AND MORE CAPITAL FORMATION AND PRICES OF CAPITAL GOODS INCREASE
• REDUCTION IN TAXES : PEOPLE’S REAL AND MONETARY INCOME INCREASES AND CAUSING INCREASING IN EFFECTIVE DEMAND
• LESS PUBLIC BORROWING : IF LESS PUBLIC BORROWING OR REPAYMENT OF OLD DEBTS
• INCREASE IN POPULATION
• INCREASE IN EXPORT
• SUPPLY SIDE

1. LESS PRODUCTION
2. ARTIFICIAL SHORTAGE
3. TAXATION POLICY OF THE GOVT
4. SHORTAGE OF FOOD GRAINS
5. INDUSTRIAL DISPUTES
6. NATURAL CALAMITIES
7. WAR INTERNATIONAL CAUSES
8. INDUSTRIAL POLICY

• SUPPLY SIDE CASUES
• REFERS TO THE QUANTITY OF AVIALABLE GOODS  OR OUTPUT ON WHICH PEOPLE SPEND THEIR INCOME
• LESS PRODUCTION : ONE OF THE SIGNIFICANT REASONS
• ARTIFICIAL SCARCITY : HOARDERS AND PROFITEERS ARTIFICAL SCARCITY OF GOODS BY HOARDING THE SAME AND CAUSE THEIR PRICES TO RISE IN THE MARKET.
• TAXATION POLICY OF THE GOVERNMENT :
• SHORTAGE OF FOODS GRAINS
• INDUSTRIAL DISPUTE
• TECHNICAL CHANGES : NEW INVENTIONS EVERT  TAKE PLACE IN WITH REDUCTION IN PRODUCTION GOING DOWN . TECHNICIAN AND SPECIALISTS ARE PAID THEIR RUMENERATION DURING THE INTERVENING PERIOD
• LACK OF RAW MATERIALS :
• NATURAL CALAMITIES : AGRICULTURE PRODUCTION IS EXPOSED TO SUCH NATURAL CALAMITIES AS EARTHQUAKE,FLOOD,DROUGHT ETC
• PRODUCTIVE SET UP : PRODUCERS PRODUCE MORE LUXRY GOODS
• WAR : PRODUCTION OF CONSUMER GOODS FALL IN WAR TIME
• INTERNATIONAL CAUSES : PRICE HIKE OF PETROL AND PETROLEUM PRODUCTS

 

• INDUSTRIAL POLICY OF THE GOVERNMENT
• BOTTLENECK IN PRODUCTION : WHEN SUPPLY OF ELECTRICITY,COAL ,MEANS OF TRASNPORT ETC BECOMES ERRATIC  THEN PRODUCTION SLOWS DOWN
• CAUSES OF INFLATION IN INDIA

 

• INCREASE IN MONEY SUPPLY:-IN INDIA SUPPLY OF MONEY HAS INCREASED MUCH MORE THAN GROSS DOMESTIC PRODUCT. SINCE THE SECOND FIVE YEAR PLANS SUPPLY OF MONEY HAS INCREASES
• DEFICIT FINANCING:-DEFICIT FINANCING MEANS PRINTING OF NOTES TO FINANCE DEFICIT ,AS A RESULT SUPPLY OF MONEY INCREASES. IF PRODUCTION DOES NOT RISE SIMULTANEOUSLY,PRICES BEGIN TO RISE. DURING FIRST FIVE YEAR PLANS IT WAS 350 CRORE AND IN THE NINTH FIVE YEAR PLAN IT WAS 64,489 CRORE
• INCREASE IN POPULATION:-INDIAN POPULATION HAS BEEN RISING SINCE 1921.RISE IN PRICES IS VERY MUCH INFLUENCED BY EXCESSIVE PRESSURE OF POPULATION. GROWTH RATE OF POPULATION HAS BEEN HOVERING ROUND 2% PER CENT PER ANNUM SINCE 1951. INDIA’S POPULATION RISE TO 121.02 CRORES
• SETBACK TO PRODUCTION: AS THE AGRICULTURE PRODUCTION IS AFFECTED BY NATURAL LIKE RAIN,DROUGHT AND FLOOD ETC. AGRO INDUSTRY IS DEPENDENT ON AGRICULTURE INPUTS. BUT THERE IS SHORTAGE OF AGRICULTUTURAL PRODUCTS SO IT WILL LEAD TO RISE IN PRICES
• INCREASE IN MINIMUM SUPPORT PRICE OF FOODGRAINS: GOVERNMENT HAS INCREASED SUPPORT PRICE FOR FOOD GRAINS. SUPPORT PRICE HERE MEANS MINIMUM FOOD GRAINS FIXED BY GOVERNMENT. INCREASE IN MSP LEADS TO INCREASE IN THE PRICE LEVEL.
• INCREASE IN WAGES AND SALARY:-IN INDIA EVERY PRICE RISE IS FOLLOWED BY A WAGE INCREASE THE C OMPOUNDING THE PROBLEM OF INFLATION. EVERY WAGE INCREASE RESULT IN COST OF PRODUCTION WHICH IN TURN LEADS TO COST PUSH INFLATION
• ADMINISTRED PRICE: REFERS TO PRICE FIXED BY GOVERNMENT FOR ESSENTIAL GOODS. PRICE LEVEL IN THE COUNTRY HAS ALSO INCREASED ON ACCOUNT OF THE FREQUENT HIKE IN THE ADMINISTERED PRICES.
• HIKE IN OIL PRICES AND GLOBAL INFLATION HAS ALSO INFLUENCED PRICE RISE IN OUR COUNTRY
• DUE TO IMPOSITION OF INDIRECT TAXES HAS ALSO CAUSED RISE IN PRICES
• UNFAVOURABLE TERMS OF TRADE
• REMOVAL OF PRICE AND DISTRIBUTION CONTROL: DUE TO THIS PRICES ARE FIXED BY THE MARKET FORCES.IT ALSO CAUSED RISE IN PRICES
• EXPECTATION OF FUTURE RISE IN PRICES
• INCREASE IN UNPRODUCTIVE PUBLIC EXPENDITURE
• CREDIT EXPANSION
• BLACK MONEY
• URBANISATION
• SUGGESTIONS TO CHECK INFLATION

1. CHECK ON SUPPLY OF MONEY
2. LESS DEFICIT FINANCING
3. INCREASE IN AGRICULTURE PRODUCTION
4. INCREASE IN INDUSTRIA PRODUCTION
5. NATIONAL WAGE POLICY
6. APPROPRIATE FISCAL POLICY
7. APPROPRIATE MONETARY POLICY
8. SUGGESTIONS
9. DISTRIBUTION THROUGH FAIR PRICE SHOPS
10. CHECK BLACK MONEY
11. CONSUMER’S ORGANIZATION
12. CONTROL OVER POPULATION
13. IMPORT OF ESSENTIAL COMMODITIES
14. GROWTH OF POWER AND TRANSPORT
15. CONTROL OVER INCREASE IN ADMINISTERED PRICES

• MEASURES BY THE GOVERNMENT TO CONTROL THE INFLATION

1. MONETARY MEASURES
2. FISCAL MEASURES
3. PRICE CONTROL

• MEASURES
• MONETARY MEASURES:-IN ORDER TO ACHIEVE THE OBJECTIVES OF PRICE STABILITY RBI OF INDIA REGULATES THE SUPPLY OF MONETARY POLICY.ADOPTED QUNATITAVIE MEASURE :BANK RATE,CASHRESERVE RATIO ETC AND QUALITIATIVE MEASURES
• FISCAL MEASURE:GOVT HAS TAKEN VARIOUS FISCAL MESURES TO CHECK INFLATION LIKE:-
• REDUCTION IN UNNECESSARY EXPENDITURE
• ADDITIONAL TAXES

1. REDUCTION IN THE QUNATUME OF DEFICIT FINANCING
2. CHECKING OF UNNECESSARY CONSUMPTION
3. VARIOUS SCHEMS TO PROMOTE SAVING
4. INCREASE IN AGRICULTURE  AND INDUSTRIAL PRODUCTION
5. GOVERNMENT HAS BANNED AND IMPOSED EXPORT DUTIES ON EXPORT OF ESSENTIAL GOODS
6. IMPORT OF ESSENTIAL GOODS
7. DUAL PRICING POLICY
8. PUBLIC DISTRIBUTION SYSTEM
9. CHECK ON HOARDING
10. GOVERNMENT HAS BUILT BUFFER STOCK OF ESSENTIAL GOODS
11. INSTITUTIONAL MEASURES:-MANY INSTITUTIONS LIKE FCI,CCI HAVE TAKEN VARIOUS STEPS TO STABALIZE PRICES OF FOOD GRAINS,COTTON AND JUTE ETC
12. PROMOTING COOPERATIVE STROE:-VARIOUS CONSUMER COOPERATIVE STORES HAVE BEEN SET UP FOR SUPPLYING ESSENTIAL GOODS AT LOW PRICES

• EVALUATION OF PRICE POLICY
• UNCORDINATED POLICY
• FAILURE TO CHECK BLACK MONEY
• DEFECTIVE PLANNING
• ADMINISTRATIVE DIFFICULTIES
• THEORIES OF INFLATION
• DEMAND PULL INFLATION
• IT IS THE OLDEST THOERY OF INFLATION. ALSO CALLED THE FIRST GENERATION THEORY WHICH WAS PREVALENT BEFORE 1970.
• MOST OF THE ECONOMISTS AGREE THAT INFLATION IS DEMAND PULL PHENOMENON, CONTINUOUS PRICE RISE TAKE PLACE DUE TO RISING DEMAND OVER AVAILABLE SUPPLY OF OUTPUT.
• INFLATION REFERS TO SITUATION IN WHICH AGGREGATE DEMAND AT THE EXISTING PRICE LEVEL FAR EXCEES AGGREGATE SUPPLY OF GOODS AND SERVICES. INFLATION ARISES DUE TO EXCESSIVE DEMAND.
• SHAPIRO” ACCORDING TO DEMAND PULL INFLATION,THE GENERAL PRICE LEVEL RISES BECAUSE THE DEMAND FOR GOODS AND SERVICES EXCEEDS THE SUPPLY AVAILABLE AT EXISTING RATES.
• BEFORE FULL EMPLOYMENT INCREASE IN AD INCREASES OUTPUT AND ALSO EMPLOYMENT
• BUT AFTER FULL EMPLOYMENT AD DOES NOT INCREASE IN OUTPUT
• PRICE LEVEL BEGINS TO RISE
• DEMAND PULL INFLATION
• DIAGRAM
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• EXPLANATION
• WHEN DEMAND INCREASES FROM D1 TO D2 AND THEN D3 AND THEN D4.PRICE INCREASE FROM P1 TO P2, THEN P3 AND P4. KNOWN AS DEMAND PULL INFLATION. WHEN DEMAND RISES FROM D1 TO D2, AND THEN D3 THEN ALONG WITH PRICE RISE PRODUCTION ALSO INCREASES.
• SUCH A PRICE RISE IS KNOWNN AS SEMI INFLATION, BUT AFTER REACHING FULL INFLATION ANY INCREASE BEYOND DEMAND LEADS ONLY TO PRICE RISE. IT IS TRUE INFLATION BECAUSE IT IS NOT FOLLOWED BY INCREASE IN PRODUCTION.
•  MAIN THEORIES OF DEMAND PULL INFLATION
• QUANTITY THEORY OF MONEY: AFTER FULL EMPLOYMENT INCREASES QUANTITY OF MONEY LEADS TO RISE IN PRICE LEVEL. QUANTITY OF MONEY IS INDENTIFIED AS SOLE CAUSE OF INFLATION.
• KEYNESIAN THEORY:ACCORDING TO KEYNES WHEN AD EXCEEDS AS,THE PRICE BEGIN TO RISE. AD=C+I WHEN CONSUMTPTION EXPENDITURE OR INVESTMENT OR BOTH RISE THERE IS TENDENCY  FOR THE PRICE RISE
• HANSEN’S EXCESS THOERY OF DEMAND: HANSEN DEVELOPED A NEW DEMAND INFLATION MODEL IN HIS BOOK,” A STUDY IN THE THEORY OF INFLATION IN 1950. IT IS CONSIDERED TO BE SUPERIOR THAN KEYNESIAN. ACCORDING TO HANSEN INFLATION ARISES DUE TO EXCESS DEMAND FOR GOODS (GOOD GAP) AND EXCESS DEMAND FOR FACTORS( FACTOR GAP) FOR FULL INFLATION THERE MUST BE BOTH GOODS AND FACTOR GAP.
• MODERN QUANTITY THEORY OF MONEY : GIVEN BY MILTON FRIEDMAN. MAIN CAUSE : EXCESSIVE INCREASE IN THE SUPPLY OF MONEY AS COMPARED TO DEMAND.
• THE TRADITIONAL QUNATITY THEORY OF INFLATION
• THE QUNAITY THEORY OF MONEY IS ONE OF THE OLDEST THEORY IN THE ECONOMICS THAT CONSTIUTE THE BASIS OF INFLATION. IT ASSUMES THAT THERE IS STABLE AND PROPORTIONAL RELATIONSHIP BETWEEN CHANGES IN THE MONEY SUPPLY AND THE PRICE LEVEL. THE THEORY IS BASED ON
• MV=PT
• M= MONEY SUPPLY
• V=VELOCITY OF MONEY
• P= AVERAGE PRICE
• T=TOTAL NUMBER OF TRANSACTIOS
• THIS THEORY REVEALS THAT AT FULL EMPLOYMENT LEVEL IN THE LONG RUN AS QUANTITY OF MONEY INCREASES PRICE LEVEL ALSO INCREASES AND IT IS BASED ON THE ASSUMPTION THAT MONEY IS MEDIUM OF EXCHANGE
• INFLATIONARY GAP
• KEYNES IN HIS ARTICLE “ HOW TO PAY FOR WAR(1940) EXPLAINED DEMAND PULL INFLATION IN THE FORM OF INFLATIONARY GAP.THE CONCEPT OF INFLATIONARY GAP REFERS TO THE EXCESS OF ANTICIPATED EXPENDITURE OVER THE AVIALABLE OUTPUT AT THE BASE PRICES.DURING WAR TIME AS INCOME OF THE PEOPLE RISES THEY WANT TO SPEND ON CONSUMPTION GOODS BUT THERE IS FULL EMPLOYMENT SO SUPPLY CAN NO BE INCREASED,
• DIFFERENCE BETWEEN THE QUANTITY OF MONEY TO BE SPENT ON CONSUMPTION GOODS AND THE ACTUAL AVAILABILITY OF SUCH GOODS IS CALLED INFLATIONARY GAP.
• THE EXPENDITURE IS DETERMINED BY CURRENT INCOME AS WELL EXPECTATION OF FUTURE INOCME. THE SUPPLY OF GOODS IS DEPENDENT UPON THE LEVEL OF EMPLOYMENT AND STATE OF TECHNOLOGY.
• KURIHARA “ AN EXCESS OF ANTICIPATED EXPENDITURE OVER AVAILABLE OUTPUT AT BASE PRICES IS CALLED INFLATIONARY GAP.
• EXPLANATION
• INFLATIONARY GAP
• D
• EXPLANATION
• OY 1 LEVEL OF INCOME IS FULL EMPLOYMENT LEVEL. AD(C+I+G)  WHEN INCREASES TO AD1 AT FULL EMPLOYMENT LEVEL. DEMAND IS FY1 BUT OUTPUT IS EYA SO AD IS MORE THAN AS THERE IS INFLATIONARY GAP OF EF. IF INCOME OR OUTPUT INCREASES TO OY2 THEN EQUILIBUIRUM WILL BE ESTABLISHED AT E1 THEN THE INFLATIONARY GAP IS PLUGGED.
• CAUSES OF INFLATIONARY GAP
• WHEN QUANTITY OF MONEY INCREASES DUE TO WHICH RATE OF INTEREST FALLS SO THAT INVESTMENT INCREASES SO THERE IS EXCESS DEMAND . IF QUANTITY OF MONEY REMAINS THE SAME INCREASE IN THE PROFITABILITY OF INVESTMENT MAY ALSO CREATES EXCESS DEMAND.
• HOW CAN INFLATIONARY GAP CAN BE REDUCED:-

1. BY INCREASING IN SAVING BUT IT MAY LEAD TO DEFLATION TENDENCIES
2. RAISE THE VALUE OF OUTPUT TO MATCH THE DISPOSABLE INCOME
3. IN THE SHORT RUN OUTPUT CAN NOT BE INCREASES BECAUSE FACTORS ARE ALREADY FULLY EMPLOYED SO THE INFLATIONARY GAP CAN BE RDUCED BY INCREASING TAXES AND REDUCING EXPENDITURE. MONETARY POLICY CAN BE USED TO REDUCE THE STOCK OF MONEY BUT KEYNES WAS NOT IN FAVOUR OF MONETARY POLICY.

 

• COST PUSH INFLATION THEORY

 

• COST PUSH INFLATION

 

• IN THIS SITUATION THERE IS RISE IN PRICES ON THE ONE HAND AND FALL IN OUTPUT AND EMPLOYMENT
• INFLATION IS ALSO POSSIBLE IN SITUATION WHERE AD IS FALLING BUT COST OF PRODUCTION IS RISING. CALLED COST PUSH INFLATION
• A,S COMPGANA “ COST PUSH INFLATION IS THE CONSEQUENCE OF RISE IN COSTS, IT IS CHARACTERIZED BY INSUFFICIENCY OF AGGREGATE DEMAND,UNEMPLOYED RESOURCES AND EXCESS CAPACITY.
• COST PUSH INFLATION THEORY
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• EXPLANATION
• DD IS THE DEMAND CURVE
• SS IS THE SUPPLY CURVE
•  A REPRESENT FULL EMPLOYMENT
• SS IS THE INITIAL SUPPLY CURVE AND CUTS DD AT E POINT  AND OM IS THE OUTPUT
• OM3 REPRESENT OUTPUT AT FULL EMPLOYMENT LEVEL
• WHEN COST OF PRODUCION RISES NEW SUPPLY CURVE ASSUMES THE SHAPE OF SIS
• INTERSECT THE DEMAND CURVE AT E1 AND PRICE RISES TO OPI

·         IF COST OF PRODUCTION RISES THEN NEW SUPPLY CURVE WILL BE S2S AND PRICE OP 2

·         PRICE LEVEL CONTINUE TO RISE BUT OUTPUT AND EMPLOYMENT CONTINUE TO FALL

 

 

• CAUSES

1. IMPERFECTLY COMPETITIVE
2. INCREASE IN THE RATE OF WAES
3. INCREASE IN THE RATE OF PROFIT
4. INCREASE IN THE KEY OF COST OF KEY INPUTS