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Macro Economics
8584992992
8584992992
B. Com. [ III year ]
University of Calcutta
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Macro Economics
8584992992
B. Com. [ III year ]
University of Calcutta
www.eblackboard.co.in
Macro Economics
8584992992
8584992992
B. Com. [ III year ]
University of Calcutta
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Macro Economics
8584992992
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University of Calcutta
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Inflation :
Inflation refers to a process of consistent and persistent rise in general price level
for a fairly long time. That means a trend of continuous rising in general price level is
referred as inflation in a macro level economy. It is generally measured by GDP
deflator. In India, consumer price index and wholesale price index are applied to do so.
There are two views to the emergence of inflation. One is classical that believes it is a
monetary phenomenon while Keynes argues it is non-monetary.
***
Macro Economics
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Demand Pull Inflation :
When inflationary situation occurs due to demand forces, it is termed as demand
pull inflation. In other words, demand pull inflation emerges in an economy when
aggregate demand for goods and services exceeds the aggregate supply available at
existing prices. Demand pull inflation can be shown with the following diagram :
P
Where
AS
E4
P4
P3
Price level
ADi = aggregate demand curves
E3
AS = aggregate supply curve
Yf = full employment level
P2
P1
E2
E1
Pi
= price levels
Ei
= equilibria
i = 1, 2, 3, 4
O
Y1
Y2
Yf
National Output
Y
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In the diagram, the potential capacity of the economy is OYf, shown by the vertical
portion of AS curve. When aggregate demand increases till full employment level, price
level as well as output level, they both increase and this situation of the economy does
not refer to a situation of inflation. Shifting of AD curves upward denotes an increase in
aggregate demand. Now, if aggregate demand increases further at full employment
level, price level increases proportionately, and this very situation is termed as demand
pull inflation. Prof. Keynes calls such a rise in price level after the attainment of full
employment output as pure inflation.
***
Macro Economics
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Causes of demand pull inflation :
Following are the main causes of demand pull inflation –
(i)
Increase in supply of money : ‘Too much money chasing too few goods’ is the
famous saying of classical economists. They believe that additional increase in supply
of money, economy has additional aggregate demand. Since full employment exists in
the economy, there is no way to increase aggregate supply, general price level will go
up and thus inflation occurs. This point of view suggests it is a purely monetary
phenomenon.
(ii) Increase in expenditure : The other famous saying is ‘too much spending
chasing too few goods’. The Keynesian view is that it is increase in expenditure that
consequence is the emergence of demand pull inflation in the economy. His four
expenditures, viz. consumption, investment, government and import if increased at full
employment level, excess aggregate demand creates inflationary situation. Thus from
this point of view, it is a non-monetary phenomenon.
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(iii) Reduction in tax : A reduction in tax rate also increases the level of income,
that further generates excess aggregate demand and ultimately inflation occurs if
aggregate supply does not coincide. It is a tool of fiscal policy to curb inflation if it
exists in the macro level economy.
(iv) Increase in population : An increase in population, too, causes excess
aggregate demand for goods and services over limited aggregate supply and thus a
cause of demand pull inflation.
(v) Black Money : A parallel economy of black money is one of the most important
factors to increase aggregate demand in the present scenario. Black money, money
without taxed, creates huge demands but supply lags behind, consequently price rises
proportionately, demand pull inflation continues.
***
Macro Economics
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Cost Push Inflation :
When inflationary situation occurs due to cost forces, it is termed as cost push
inflation. In other words, it is cost of production that affects aggregate supply inversely
and creates inflation in an economy. A rise in prices of cost of production like wagerate, cost of raw materials, increase in tax rate etc. will reduce aggregate supply that
tends to price rise in an economy and termed as cost push inflation. A graphical
presentation of cost push inflation is shown below :
Where
AS
P
AD = aggregate demand curve
Price level
ASi = aggregate supply curves
Yf = full employment level
Yi = different equilibrium output levels
E3
P3
P2
P1
E2
E1
Pi
= price levels
Ei
= equilibria
i = 1, 2, 3, 4
O
Y3 Y2
Y1
Yf
National Output
Y
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In the diagram, initially AD curve intersects AS1 curve at E1, therefore equilibrium
price is P1 and equilibrium output is Y1. An increase in cost of production results in
leftward shifting of aggregate supply curve to AS2, while AD curve remains unchanged,
a new equilibrium level reduced to OY2 but price level rises to OP2. Likewise, shifting of
AS2 to AS3,, the price level rises to OP3 and output level falls to OY3. A series of
increase in cost of production results a series of leftward shifting of AS curves,
indicating that the whole economy is under inflationary process.
***
Macro Economics
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Causes of cost push inflation :
Following are the main causes of cost push inflation –
(i)
Increase in cost of inputs : The cost of four basic factors of production when
increased, cost of output also increased. Thus raised cost raises the prices of goods
and services. Consequently, aggregate supply reduces but price level rises and the
rising trend in price level is termed as inflation.
(ii) Increase in taxes : Increase in tax rates like indirect tax, excise duty, custom
duty etc., also have a positive relation with cost of production. Such increase will
reduce aggregate supply, if the situation persists in an economy for a fairly long time,
called it cost push inflation.
(iii) Hoarding : Hoarding i.e., shortage of inventory deliberately is another cause of
rising in prices of goods and services. An artificial scarcity in supply is created to raise
the price.
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(iv) Increase in oil prices : In a present world economy, petroleum products are
used directly or indirectly in all the sectors of an economy. Therefore, an increase in oil
prices affect significantly the cost structure of an economy and thus creates inflation.
(v) Corruption : Corruption is the another factor to raise in cost of production.
Redtapism and license system create production process in stall. Prices keep on rising
trend.
***
Macro Economics
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Difference between demand pull inflation and cost push inflation :
Inflation is a continuous rising trend in price level in an economy. Broadly there are two
types are discussed to understand inflation. One is demand pull inflation and other is
cost pull inflation. They both explain rising trend in price level but have some
differences mentioned below :
(i)
Demand pull inflation occurs due to demand forces while cost push inflation
due to cost forces. Rising in aggregate demand due to increase in money supply or
expenditures, reduction in taxes etc. creates demand pull inflation. Rising in cost of
production due to increase in wage rate, prices of raw materials, increase in tax
reduces aggregate supply and inflationary situation occurs in the economy.
(ii) Demand pull inflation is monetary and non-monetary phenomena while cost
push inflation is only non-monetary phenomenon.
(iii) Demand pull inflation occurs only when full employment is in the economy
while cost push inflation may takes place before full employment level.
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(iv) During demand pull inflation, aggregate supply remains unchanged while
during cost push inflation, aggregate supply reduces.
(v) Demand pull inflation may be controlled by fiscal as well as monetary
measures while these measures are not completely effective to check cost push
inflation.
***
Macro Economics
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B. Com. [ III year ]
University of Calcutta
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Effects of inflation on different sections of society :
Inflation affects different sections of society. If one section is inversely affected, on the
contrary the section gets benefited. The impact of inflation on different sections of
society can be discussed as under (i)
Debtors and creditors : Debtors are gainer while creditors are loser during the
period of inflation. Debtors get benefited because they borrow money when its
purchasing power is higher during pre inflation period but when they return the sum to
the creditors during inflation period, the purchasing power of money is lower due to
price rise. Inflation reduces purchasing power of money though its face value remains
unchanged.
(ii) Wage-earner and salaried class : They both classes are affected inversely.
Wage rate increases lag behind price increases. Obviously inflation results in a
reduction in real purchasing power of fixed income earners.
Macro Economics
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(iii) Investors : Inflation is beneficial for those investors who invest in equities
because dividends increase as a result of increase in capital profits. On the other
hands, the investors who invest their money in the form of bonds, debentures and
deposits with commercial banks suffer loss because they earn only a fixed interest
income from such investment.
(iv) Profit earners : Inflation helps to earn more profits to entrepreneurs, traders
because the value of their inventories is rising. Therefore, impact of inflation becomes
positive for them
(v) Exports and imports : Inflation has an adverse impact on balance of payment.
Inflation makes export costlier and import cheaper, export reduces and import rises.
Consequently, balance of payment becomes unfavourable.
***
Macro Economics
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University of Calcutta
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Controls of inflation :
There are two policies to control inflation. The one is monetary policy, regulated by the
Central Bank of the nation and the other is fiscal policy which is governed by the
government.
a)
Monetary policy : There are two techniques adopted by the Central Bank for the
purpose of curbing inflation in the economy. One is quantitative measures and
other is qualitative measures.
(i)
Quantitative measures – Bank rate, cash reserve ratio, open market operation
are such measures which help to control inflation. Increase in bank rate and
CRR decrease credit creation of commercial banks. Supply of money is
reduced resulting a rise in interest rate. Demand for money falls and finally
inflation comes under control. In addition, the apex bank performs open
market operation means it sells government bonds, commercial banks and
financial institutions purchase them. Supply of money in the economy is
reduced and that has a positive impact for controlling inflation.
Macro Economics
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Qualitative measures – The Central Bank issues directives to commercial banks so that
their lending come under control so that credit policy should be under pressure. The
apex bank also provides advice, appeal and persuade the commercial banks by moral
suasion to achieve the same purpose.
b) Fiscal policy : Fiscal policy is the policies of the government expenditure and its
revenue. As Keynes believes that expenditure is the causing factor of inflation.
When such expenditures are reduced, aggregate demand will be reduced and
ultimately it helps to curb inflation in the economy.
The other fiscal measure is increment in existing tax rates as well as imposing
new taxes that will be helpful to control increased aggregate demand. An
increment in direct tax is more effective because it reduces disposable income
resulting purchasing capacity falls and then price level come down in the
economy.
Rationing and price control policy are also taken by a government to curb the
same. It fixes the maximum price of commodities to control price level.
Macro Economics
8584992992
B. Com. [ III year ]
University of Calcutta
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Macro Economics
8584992992
B. Com. [ III year ]
University of Calcutta
20
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Macro Economics
8584992992
B. Com. [ III year ]
University of Calcutta
21
www.eblackboard.co.in