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Inflation & Its Measurements
What we are going to learn today
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What is Inflation
Introduction of inflation
Definition of inflation
Major Kinds of inflation
Other kinds of inflation
Measurements of inflation
Assignment
INFLATION ?
Introduction
Inflation is a process in which there is
continuous increase in the general price level
and the money is continuously losing its
value. It may here be noted that rising
general level of prices does not mean that the
prices of all goods are necessarily rising.
Even during inflation, prices of some goods
may remain relatively constant.
Definition of Inflation
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According to R.P Kent:Inflation is nothing more than a sharp upward
movement in the price level.
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According to Crowther:Inflation is a state in which the value of
money is falling i.e. prices are rising.
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According to Coulborn:In inflation, too much money chases too few
goods.
Major Kinds of Inflation
Demand Pull
Inflation
Cost Push
Inflation
Demand Pull Inflation
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An inflation where aggregate(Total)
demand for goods & services
increases but aggregate(Total) supply
of goods is constant. In other words
when aggregate demand does not
match with supply, it leads to increase
in general price level e.g. increase in
population etc.
Diagrammed show
S
P2
P1
D2
D1
Cost Push Inflation
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An inflation, which occurs due to
shortage in supply of goods and
services. In this case demand is
constant but supply falls due to
increase in cost of production e.g.
taxes on raw material ,war or
floods etc.
Diagrammed show
S2
S1
P2
P1
D
Characteristics of Inflation
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Increasing Prices
Excess money
Disequilibrium in demand & supply
Other Kinds of Inflation
Profit
Inflation
Income
Inflation
Deficit
Inflation
Production
Inflation
Wage Spiral
Inflation
Devaluation
Inflation
Profit Inflation
Profit inflation is the result of greed of
businessman. it usually occur in such
economy which are dominated by
monopolies. Monoplist is in a position to
increase the price of his product at his
will. As no substitute are available so
people are forced to purchase his
products at high prices. Thus it leads to
exploitation of masses and inflation as
well.
Income Inflation
The inflation that occurs from high income level
is called income inflation. Income of masses
may increase due to change in the salary
structure of govt. are due to foreign remittances.
In consumption oriented society where
propensity to consume is higher than propensity
to save such higher income will induce people
to spend lavishly on consumer goods. This will
add to the demand pull inflation.
Deficit Inflation
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When revenues of government are less than
its expenses govt. is said to run budget
deficit. To overcome this deficit govt. make
borrowings from both internal and external
sources. the borrowing increase the govt.
expenditures
without
producing
corresponding increase in real output. This
increase the supply of money in the
economy. Higher supply induces more
consumption causing price level to rise.
Production Inflation
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Production inflation arises due to lack
of capital projects. If the process of
industrialization is slow as compare
to the rate of growth of population,
then soon the economy would be
unable to meet all the needs of its
members. Shortage of various goods
will motivate supplier or stockiest to
force up prices.
Devaluation Inflation
Devaluation leads to inflation. ( However,
many economists are of the view that it is
inflation which leads to Devaluation).
Devaluation makes our currency cheap in
term of foreign currency. It also makes all
those goods cheap which are priced in
rupees. Consequently exports price fall and
import prices rise. Higher imported price of
raw material increases domestic cost of
production causing inflation.
Causes of inflation
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Demand Pull Inflation
Cost Push Inflation
Causes of Inflation In Pakistan
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Deficit Financing
Devaluation
Decrease in Production
Population Explosion
Increase in Wages
Increase in Export of Consumer goods
Oil Crisis
Increase in Indirect Taxation
Natural Climates
Psychological Factors
Social Evils
Causes of Inflation In Pakistan
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Deficit Financing
The govt. may prepare deficit budgets to complete its various
projects. A large part of development expenditure is done out
of deficit financing, which increase supply of money.
Devaluation
Devaluation brings inflation due to rise in the prices of
imports, increases purchasing power of exporters, more
exports and low imports, Psychological factors.
Causes of Inflation In Pakistan
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Decrease in Production
Due to agricultural and industrial backwardness there is
shortage of commodities in the country. So prices are
increased which creates inflation in the country.
Population Explosion
In Pakistan population is increased at the rate of about
2.1%. The pressure of population has increased the
aggregate demand, which leads to inflation.
Consumption Habits
People of countries like Pakistan are mostly spendthrifts.
Such consumption trends generate artificial shortages of
resources and causes inflation.
Causes of Inflation In Pakistan
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Increase in Wages
The rise in wages, salaries increases the purchasing power of
the people. Wages and prices chase each other. When
wages are increase then prices are also increased. This will
cause inflation.
Increase in Export of Consumer goods
Due to increase in export of consumer goods & raw goods to
foreign market, the quantity of goods is decreased in the
country. Therefore general price level is increased.
Oil Crisis
The oil crisis in 1973 created a large quantity of inflation
throughout the world. Due to increase in prices of petroleum
the price of each and everything is increased & cause
inflation.
Causes of Inflation In Pakistan
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Increase in Indirect Taxation
For increasing the revenue, the govt. impose indirect taxes. The
increase in the indirect taxes raises the prices of goods and
services causing inflation.
Natural Calamities
Natural calamities such as flood, Famines and earthquake also
causes inflation by decreasing the supply of goods and tends
the prices to go up.
Psychological Factors
As inflation continues, people fear more Sharpe rise in prices in
the future. The consumer tries to buy today and seller to sell
tomorrow and cause inflation.
Social Evils
Various social evils like black money or smuggling also causes
inflation.
Measures to Remove Inflation
Monetary
Measures
Fiscal
Measures
Other
Measures
Monetary Measures
Quantitative
Control
Qualitative
Control
Quantitative Control
Interest
Rate
Policy
Credit
Rationing
Change
in
Reserve
Ratio
Open
Market
Operations
Quantitative Control
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Interest Rate Policy
It means the rate of interest at which the commercial banks grant loans against
first class securities according to the instructions of central bank. In case of
inflation, the bank interest rate is raised which discourages borrowings, as a result
credit contracts. On the other hand if there is deflation, the bank interest rate is
lowered which encourages the borrowings as a result credit expand.
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Credit Rationing
The central bank puts limit s for the grant of credit. The credit is rationed for each
bank during financial crisis. If the central bank deposits expantionary monetary
policy the rationing limit of loans increases. On the other hand if the central bank
adopts the contractionary monetary policy the rationing limit of loans decreases.
Quantitative Control
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Change In Reserve Ratio
Every member bank is required to keep a certain amount of its total deposits
as cash reserves with central bank. If there is more quantity of money in the
country, the ratio is raised which reduces the credit base of banks and credit
contracts. on the other hand, if there is less quantity of money then the ratio
is reduced which increases the credit base of banks and credit expand.
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Open Market Operations
It means purchase and sale of securities by central bank in open market. If
there is more quantity of money, the central bank sells securities in market.
Buyers make cash payments through commercial banks, so as a result
credit contracts. On the other hand if central bank wants to increase the
quantity of money in a country then he buys securities and makes payment
in cash, as a result credit expands.
Qualitative/Selective
Control
Direct
Action
Publicity
Restriction
on
Advances
Changes
in
Margins
Qualitative/Selective
Control
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Direct Action
When the central bank realizes the fact that its policies regarding
credit control are not being implemented then he takes following
direct actions:
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Declares the scheduled banks as non scheduled
banks and takes the facilities back
Increases the ratio of cash reserve
Refuses to re-discount the bills of exchange of
scheduled banks
Publicity
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Central bank keeps the nation well informed about economic
conditions through news papers, radio and television etc. which
enables the people to understand the economic condition of the
country. Publicity throws a light on the following points:
 Policies of business concerns, their production and
production targets
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Deposits of capital, quantity of loans, interest are of
banks and level of inflation or deflation.
Restriction on Advances
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In severe economic problems, the central
bank may impose restrictions on commercial
banks to grant loans. The central bank tries
its level best to avoid this tool of credit control
policy.
Changes in Margins
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Margins means the difference between the
amount of loan and the value of security. The
minimum margin requirement on securities
may be relaxed to encourage the borrowings
and can be imposed to discourage the
borrowing.
Fiscal Measures
Increase
in
taxation
Reducing
public
sector
borrowings
Reducing
Check on
exports on
indirect
essential items taxation
Fiscal measures
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Increase in taxation
The increase in taxes means part of income of people will be
transferred to govt. the purchasing power of general public will
decrease. In this way inflation is controlled.
Reducing public sector borrowings
To control inflation govt. should reduce its borrowings from the public
sector.
Check on exports on essential items
The surplus goods may be exported but the item , which are short at
home market, should not be exported. The essential items cannot be
exported in this way & inflation is controlled.
Reducing indirect taxation
To control inflation indirect taxes should be reduced.
Other measures
Control
over wages
and salaries
Control over
Imports
Reducing
Reduction in Population
investments Foreign aids Control
Controlling
Devaluation
Check
Against hoarding
And smuggling
Other measures
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Control over wages & salaries:
Govt should establish committees to maintain rate of wages and
salaries. Unnecessary increase in wages leads to inflation.
Reducing in foreign aids:
Foreign aid increases the supply of money in the country so to
control inflation there is a need to control foreign aid.
Population control:
Increase in population also leads to demand-pull inflation. So
population control may be long term policy to control inflation.
Other measures
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Control over imports:
Gov. should take steps to control imports. This will help in
maintaining balance of payments.
Controlling devaluation:
Gov. should control the rates of devaluation. Devaluation
leads to increase in the prices of imports. Hence, inflation
occurs.
Check against hoarding and smuggling:
The strict punishments should be given so that artificial
shortage of commodities may be controlled to remove
inflation.