24/06/2021
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**Meaning of Inflation
Generally, inflation is a substantial and rapid rise in general price levels and thereby a decline in the purchasing power of money. Inflation is the increase in the prices of goods and services over time. It is an economic term that means people must spend more to get their demands fulfilled (to fill their gas tank, buy a gallon of milk, or get a haircut). Inflation thus increases the cost of living.
While it is easy to measure the price changes of individual products over time, human needs extend much beyond one or two such products.
Individuals need a big and diversified set of products as well as a mass of services for living a comfortable life. They include commodities like food grains, metal and fuel, utilities like electricity and transportation, and services like healthcare, entertainment, and labor. Inflation aims to measure the overall impact of price changes for a diversified set of products and services and allows for a single value representation of the increase in the price level of goods and services in an economy over some time.
As a currency loses value, prices rise, and it buys fewer goods and services. This loss of purchasing power impacts the general cost of living for the common public which ultimately leads to a deceleration in economic growth. The consensus view among economists is that sustained inflation occurs when a nation's money supply growth outpaces economic growth.
To combat inflation, a country's appropriate monetary authority, like the central bank, then takes the necessary measures to manage the supply of money and credit to keep inflation within permissible limits and keep the economy running smoothly.
**Some Major Scholarly Definitions of Inflation
According to Arthur Cecil Pigou, inflation takes place โWhen money income is expanding relatively to the output of work done by the productive agents for which it is the payment.โ
J.M. Keynes, โInflation is the result of excess of aggregate demand over the aggregate supply and the true inflation starts after full employment. For Keynes, the rise in price level before full employment is semi-inflation.โ
Paul A. Samuelson, โInflation occurs when the general price level of prices and cost is rising.โ
Gardner Ackley, inflation is โpersistent and appreciable rise in the general price level or average of prices.โ
Edward Shapiro, โInflation is defined as a persistent and appreciable rise in the general level of prices.โ
According to Milton Friedman, โInflation is always and everywhere a monetary phenomenon.โ
According to Coulbourne, inflation is โToo much money chasing too few goods.โ
**Important Characteristics of Inflation
Inflation is the persistent and appreciable rise in the general price level and decline in the value of money or purchasing power of the individuals. It is not related to the expensiveness of only one or two goods rather related to the continuous increase in prices of almost all the goods and services. Major characteristics of Inflation are expressed as below.
โข Inflation is regular and continues to rise in the general price level.
โข It is cumulative, because even a small rise in price in beginning may take a very large shape in the future.
โข Inflation is the situation of an increase in the general price level not the increase in individual prices.
โข During inflation, the supply of goods and services is less in comparison to their demand. It means AD is higher than AS.
โข Inflation is also caused by the monetary factor. It means the price of goods and services increases due to an increase in the supply of money.
โข As prices rise, the money buys less. That is how it reduces the standard of living over time.
**Causes of Inflation or Classification of Inflation based on Causes
Inflation can occur in almost all products or services, including need-based expenses such as housing, food, medical care, and utilities, as well as want expenses, such as cosmetics, automobiles, and jewelry. Once inflation becomes prevalent throughout an economy, the expectation of further inflation becomes an overriding concern in the consciousness of consumers and businesses equally.
Inflation can be an alarming concern as it makes money saved today less valuable tomorrow. Inflation erodes a consumer's purchasing power and can even interfere with the ability to retire. For example, if an investor earned 5% from investments in stocks and bonds, but the inflation rate was 3%, the investor only earned 2% in real terms.
Numerous factors can drive prices or inflation in an economy. Typically, inflation results from an increase in demand for products and services or an increase in production costs. Based on such facts it can be classified into two broad and important categories as demand-pull inflation/demand-side inflation and cost-push inflation/supply-side inflation.
**Demand-Pull Inflation/ Demand Side Inflation
Demand-pull inflation can be caused by strong consumer demand for a product or service. When there is a surge in demand for goods across an economy, prices increase, and the result is demand-pull inflation. Consumer confidence tends to be high when unemployment is low, and wages are risingโleading to more spending. Economic expansion has a direct impact on the level of consumer spending in an economy, which can lead to a high demand for products and services.
With more money available to individuals, positive consumer sentiment leads to higher spending, and this increased demand pulls prices higher. It creates a demand-supply gap with higher demand and less flexible supply, which results in higher prices. Following fiscal as well as monetary factors may be responsible for demand-side inflation.
Monetary Factors
โข The rise in the money supply
โข Availability of more credit facility
โข Fall in interest rates
Fiscal Factors
โข Increase in spending
โข Cut in taxes
โข The surge in subsidies and transfers
โข Repayment of past debts/financial management
The effect of all mentioned monetary and fiscal factors is to boost an effective demand in an economy. In all such cases of monetary factors as well as fiscal factors money supply increases, the money loses its purchasing power. When an increase in the supply of money and credit stimulates the overall demand for goods and services in an economy to increase more rapidly than the economy's production capacity. These further increases demand and lead to price rises.
**Cost-Push Inflation/ Supply Side Inflation
Cost-push inflation occurs when prices increase due to increases in production costs, such as raw materials, wages, and profit. The demand for goods is unchanged while the supply of goods declines due to the higher costs of production. As a result, the added costs of production are passed onto consumers in the form of higher prices for the finished goods.
It is an outcome of the increase in prices working through the production process inputs. When additions to the supply of money and credit are channeled into a commodity or other asset markets and especially when this is accompanied by a negative economic shock to the supply of the key commodity, costs for all kinds of intermediate goods rise. These changes lead to higher costs for the finished product or service and work their way into rising consumer prices.
Cost-push inflation develops because of the higher costs of production and factors decreases in aggregate supply (the amount of total production) in the economy. Since fewer goods are being produced (supply weakens) and demand for these goods remains consistent, the prices of finished goods increase (inflation) is called cost-push inflation. Shortages or cost increases in labor, raw materials, and capital goods can create cost-push inflation. Thus, inflation that occurs because of the pressure of increased cost is called cost-push inflation. The following factors may be responsible for supply-side inflation.
โข Increase in wage rate more than the increase in productivity
โข Increase in profit margin
โข Rise in taxation
โข Supply shocks
โข The initial phase of the industrial revolution
โข Natural calamities and disasters
The impact of all the factors of supply-side inflation is a reduction in production and supply of goods and services. This will lead to an economy towards recession and depression.
Cost-push inflation is more dangerous than demand-pull inflation because it reduced output, employment, and income with an increase in the price level. This means that cost-push inflation leads an economy towards less than full employment equilibrium.
**Structural Inflation
In the developing and least developed countries along with monetary as well as fiscal factors, other several factors are majorly responsible for rising inflation. It means an increase in the general price in developing and LDCs is attributed to various non-monetary and non-fiscal structural factors like geographical location, weak and corrupted administration, and so on. Thus, in the LDCs following structural issues are more responsible for inflation.
โข Infrastructural blockages
โข Labour bottlenecks/ sufficient labor but most of them are unskilled
โข Imperfect market/syndicate/cratering/uneven flow of information
โข Capital bottlenecks /expensive foreign capital
โข Food bottlenecks/black-marketing/artificial shortage
โข Foreign exchange bottlenecks/low or no sufficient reserve of foreign currency
Thus, in the least developed countries, inflation occurs due to different structural factors probably more than due to monetary and fiscal factors and such inflation may be termed as structural inflation.
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