eco chapter 5

1. CONCEPT OF
INFLATION &
STAGFLATION

2. Inflation
 Inflation refers to general rise in prices
 According to Prof. Crowther “inflation is a state in
which the value of money is falling i.e. Prices are
rising”
 There are various types of Inflation

3. Types of Inflation
 Basis of Rate Inflation
 Creeping Inflation
 Walking Inflation
 Running Inflation
 Galloping Inflation
 Hyper Inflation
 Basis of Govt Intervention
 Basis of Coverage
 Time Period
 Basis of Causes
 Credit
 Scarcity
 Deficit
 Currency
 Profit
 Tax
 Wage
 Foreign trade
 Stagflation

4. Types of Inflation –
Basis of Rate Inflation
 Creeping Inflation – 3% p.a. , mild inflation,
tolerable
 Walking Inflation – 3-6% p.a. – should be taken
care of not converting into running inflation
 Running Inflation – 10-20% p.a.
 Galloping Inflation – More than 20% - serious
problem – will harm all sectors of economy

5. Types of Inflation –
Basis of Rate Inflation
 Hyper Inflation
 price rise will be at every moment – change in price will be difficult to
measure
 In terms of %, it would be more than 1000% per year
 Austria, Hungary, Poland, Germany & former USSR experienced hyper
inflation during World War I
 Germany experienced severe hyper inflation in 1924
 Prof Samuelson, described hyper inflation in a statement, “we used to
go to store with money in our pockets & come home with food in our
baskets, now we go with money in our baskets & return with foods in

6. Types of Inflation
 Basis of Govt Intervention – Open, Repressed Inflation
 Basis of Coverage – Sporadic (in 1 particular sector
only) Comprehensive (Covers entire economy)
 Time Period – Peacetime, War Time, Post war time
 Basis of causes
 Credit Inflation – banks create credit – more money supply
– more demand for goods & services – if supply of goods &
services is less than demand then price rises

7. Basis of Causes
 Scarcity Inflation – scarcity of goods & services due to
fall in production or artificial hoarding
 Deficit Inflation – when BOP is in deficit – central bank
resorts to deficit financing i.e. creation of new money
by launching new projects – leading to more supply of
money – more demand of goods – hence rise in price
 Currency Inflation – supply of money is more than
supply of goods & services hence price rise

8. Basis of Causes
 Profit Inflation – Excess profits earned by
entrepreneurs – inflation causes them to earn
more profits – thereby investing more – more
supply of money – more demand of goods – hence
rise in price
 Wage / Cost Inflation – price rise due to rise in cost
of production – costs includes wages, rent, interest

9. Basis of Causes
 Foreign Trade induced Inflation – export induced -
international demand increases but the supply is not
able to match demand – price rises
 Import induced – rise in price of imported components –
rise in price of final product
 Stagflation – emerged post WW 2, situation where
high rise in price with high rate of unemployment – co-
existence of stagnation & inflation called as Jobless
Growth

10. Stagflation In India
 In India, stagflation refers to a situation of slow growth
rate or recession along with high rate of inflation
 India experienced stagflation from 1991-1994 Factors
responsible for stagflation were
 Decline in public sector investment, restrictions on
imports, high rate of interest, increase in money
supply, rise in price of oil & other prods like coal, steel,
cement etc.

11. Stagflation In India
 Govt tried curb inflation by reducing money supply
in mkt, reducing fiscal deficit to control demand &
boost supply
 Due to govt efforts, growth rate improved lowering
the rate of inflation & unemployment
 Since 2014, oil prices have reduced leading to fall
in rate of inflation

12. Demand Pull Inflation
 Developed by J.M. Keynes
 It arises due to aggregate demand of goods & services is
more than its supply
 Demand may be more, due to increase in money supply
 It is associated with full level of employment i.e. all the
resources of nations are completely employed
 In such scenario, demand increases as money supply has
increased in market
 However, Supply cannot be increased as resources are
fully utilized

13. Cost Push Inflation
 Refers to rise in price level due to rise in cost of production
 It may occur due to rise in wage rate or due to rise in rate
of profit. Wage is a major component in cost
 Employers try to pass on this additional cost to the
customers by increasing price thereby increasing cost of
living
 Workers will further ask for revision in wage as cost of
living is increasing
 Inflation may also occur when profit margin is increased i.e.
Profits being determined on the basis of mark-up over cost

14. Causes of Inflation
 Expansion of Money
Supply
 Increase in Disposable
Inc External Demand
(Export)
 Rise in Expenditure
 Inadequate Resources
 Hoarding & black
Marketing
 Natural Calamities
 Exports
 Full Employment
Factors influencing
Demand Side
Factors influencing
Supply Side

15. Effects of Inflation on
Production
 Adverse effect on Capital Formation – Reduction in
savings as cost of living rises – less savings will lead to
less investment & poor capital formation
 Production distortion – inflation distorts production by
diverting resources to the production of non-essential
goods (higher profit margin) from essential goods (lower
profit margin)
 Hoarding & black Marketing
 Speculation
 Profit Orientation & Quality Deterioration

16. Effect of Inflation on Distribution of
Income & Wealth
 Cost of production of goods tend to increase during inflation,
however, price rises more than rise in cost of production thereby
increasing profit
 During inflation, businessmen, traders, speculators gain maximum
 Worst affected section is the fixed income group
 When worker class tries to get increment on their current salary, it
results in cost push inflation
 Debtors & Creditors are affected differently – Debtors benefit as
when they are repaying the loan the value of money has fallen and
creditors lose as the money received by them is not the same in
terms of real money

17. Effect of Inflation on Distribution of
Income & Wealth
 People who invest in shares or bonds will gain more due to higher
profits earned by firms
 On the other hand, people investing in assets reaping fixed income
(Fixed Deposit etc) will be in loss
 Farmers benefits from inflation as they would earn more on the
products produced. It will also increase the cost of production but
rise in price is more than rise in cost.
 However, the advantage is gained by rich farmers than poor
farmers
 Thus, inflation redistributes income in favour of businessmen,
debtors & farmers at the expense of fixed income group, creditors

18. Social & Political Effects of
Inflation
 Inflation helps rich to become richer & makes poor
more poorer
 Inequality widens, leading to social injustice
 Inflation helps businessmen & traders to sell sub-std
products at higher rates, black marketing etc.
 People start losing confidence in govt if it does not
intervene to curb the inflation thus creating issues in
social harmony & political stability

19. Measures to Control
Inflation
 Various measures are required to control inflation
 Inflation is caused due to disequilibrium in demand &
supply, hence measures are directed towards
influencing them
 Following are the measures adopted to curb inflation
 Monetary Measures
 Fiscal Measures
 Other Measures

20. Monetary Measures
 Inflation arises due to more money supply in market
hence central bank tries to control the money supply
by controlling the credit created by commercial banks
 Central bank uses 2 methods – quantitative &
qualitative
 Quantitative Method – controlling the volume of credit
in market
 Qualitative Method – controlling the direction of credit
by consumer credit regulation, changing the margin

21. Fiscal Measure
 Measures related to taxation, public expenditure &
public debt is known as fiscal measures. Govt uses
these factors to curb inflation
 Reduce demand by increasing taxes of goods &
services, increasing direct tax on income
 Reduction in public expenditure
 Public Debt – borrowing money from public will reduce
the money supply in market thereby reducing inflation

22. Other Measures
 Incentives are offered by govt to producers of
essential items
 Efforts are undertaken to increase the supply of
goods (so that excess demand can be managed)
 Controlling the prices of essential items
 Import of essential items if acute shortage
(depends on position of BOP)

23. Deflation
 Refers to a situation where prices keep declining
along with fall in employment, output & income
 Opposite of inflation
 Decline in prices could be due to govt measures,
however it would not be termed as deflation
 Deflation only occurs when the fall in price is
accompanied by decline in output, employment

24. Questions
1. Explain inflation and its various types
2. Stagflation in India (including Demand Pull & Cost Push
Inflation)
3. Causes of Inflation
4. Effect of Inflation (Any 2 can come for a long answer or
any 1 can come for Short Note)
5. Measures to Control Inflation (Any 1 can come for Short
Note)
6. Deflation – Short Note