Inflation in Economics

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What is Inflation?

Inflation can be defined as the persistent increase in the price level of goods and services in an economy over a period of time.

If the rise in prices exceeds the rise in output, the situation is called inflationary situation.

Inflation can take place due to various reasons. One of the major reason is a rapid increase in money supply which leads to a decrease in interest rate.

Inflation Definition

Some of the important inflation definitions are:

Inflation is a rise in the general level of prices.Samuleson Nordhaus
Inflation can be defined as, “too much money chasing too few goods.Coulborn
Inflation is an upward movement in the average level of prices. Its opposite is deflation, a downward movement in the average level of prices. The boundary between inflation and deflation is price stability.Parkin and Bade
The word inflation in the broadest possible sense refers to any increase in the general price-level which is sustained and non-seasonal in character.Peterson
nflation is an increase in the quantity of money faster than real national output is expanding.Johnson

Read: What is Business Economics?


Inflation Causes

So what exactly causes inflation in an economy? 

Causes of inflation are:

  1. Demand Pull Inflation
  2. Cost Push Inflation
  3. Built In Inflation
Inflation Causes
Inflation Causes

Demand Pull Inflation

  • Arises when aggregate demand in an economy outpaces aggregate supply.

  • It involves inflation rising as real gross domestic product rises and unemployment falls. This is commonly described as “too much money chasing too few goods”.

  • Possible causes of demand pull inflation:
     Excessive investment expenditures
     Excessive growth of consumption expenditures
     Low-cost loans
     Tax cutting
     Augmentation of government expenditures

Cost Push Inflation

  • is a type of inflation caused by large increases in the cost of important goods or services where no suitable alternative is available.

  • Possible causes of cost-push inflation:
     Imperfect competition
     Increased taxes
     Rising wages
     Political incidents (like oil crises)

Built In Inflation

  • Induced by adaptive expectations, often linked to the “price/wage spiral

  • It involves workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices as part of a “vicious circle.

  • Built-in inflation reflects events in the past, and so might be seen as hangover inflation.

Read: Difference Between Micro and Macro Economics


Characteristics of Inflation

Inflation is desirable in a country at moderate levels. However, there is no universally acceptable limit of inflation. Depending on the contribution, a country decides the acceptable limit of inflation.

Characteristics of Inflation are:

  • Inflation is followed by the price rise.
  • The cause behind inflation is increase in the money supply. Thus, it is a monetary phenomenon.
  • Due to interaction among various economic forces, inflation is also an economic phenomenon.
  • Inflation occurs in a dynamic environment over a period of time.
  • Inflation is always scarcity oriented and occurs in a disequilibrium state of economy.
  • The rise in prices in inflation cannot be reversed.
  • Inflation is persistent in nature. Generally, inflation is categorised on the basis of its rate.

Read: Scope of Economics


Types of inflation

Let us discuss these three types of inflation in detail.

3 Types of inflation are:

  1. Moderate inflation
  2. Galloping inflation
  3. Hyperinflation
Types of inflation
Types of inflation

Moderate Inflation

Moderate Inflation is a type of inflation that takes place when there is a rise in the prices of goods and services at a single rate annually. Moderate inflation is also known as creeping inflation.

At the time of moderate inflation in an economy, the prices of goods and services increase only at a moderate rate. However, the rate of increase in prices differs in different countries. It is easy to anticipate moderate inflation; therefore, individuals hold money as a store of value.

Galloping Inflation

Galloping Inflation is a type of inflation that takes place at the time of the rise in the prices of goods and services at a two-digit or three-digit rate per annum. Another name for galloping inflation is as jumping inflation.

In the words of Baumol and Blinder, “Galloping inflation refers to inflation that proceeds at an exceptionally high.”

The worst sufferers of galloping information are middle and lower class individuals. Due to this, people are unable to save money for the future. This kind of situation requires strict measures to control inflation

Hyperinflation

Hyperinflation is a type of inflation that takes place when the rate of increase in prices is extremely high or out of control. In other words, hyperinflation occurs when the increase in prices is more than a three-digit rate annually.

The cause behind hyperinflation is the unrestricted increase in the supply of money in the market. This results in a situation of imbalance in the supply and demand for money. Consequently, money loses its real worth at a rapid speed.

Read: What is Law of Supply?


Effects of Inflation

  1. Redistribution effect of inflation
  2. Social impact of inflation
  3. Impact on economy balance

Redistribution effect of inflation

  • Inflation affects recipients of fixed income firstly (nominal incomes remain same but the real value of income drop)
  • Inflation affects the purchasing power of wages that don’t follow the rise of prices
  • Inflation causes diminishing value of loans and savings

Social impact of inflation

  • Socially poor persons suffer from inflation more then rich

Impact on economy balance

  • Fall of real product bellow potential product
  • Changes in the structure of consumption (consumers are buying cheaper goods)
  • In case of fixed currency exchange rate higher exports are incited
  • Inflation deforms prices
  • Inflation causes higher costs and makes the economy less efficient
  • Creeping and anticipated inflation has a positive effect on the economy and stimulates economic growth
  • High inflation and not anticipated inflation are serious problems in the economy.

Read: Law of Demand

Reference
  1. D N Dwivedi, Managerial Economics, 8th ed, Vikas Publishing House

  2. Petersen, Lewis & Jain, Managerial Economics, 4e, Pearson Education India

  3. Brigham, & Pappas, (1972). Managerial economics, 13ed. Hinsdale, Ill.: Dryden Press.

  4. Dean, J. (1951). Managerial economics (1st ed.). New York: Prentice-Hall.


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