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Inflation a strategy to check it
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Content
Introduction Important characteristics
Features of Aggregate Demand Vs Aggregate Supply
Factors causing demand pull / cost push
Types of Inflation
Measurement of InflationWPI & CPI
Inflation levels across developed & developing economy
Phillips curve
Effect & Impact on Economy
Strategic control mechanism Life cycle of inflation
Summary
References
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Introduction
Inflation refers to a rise in price level afterfull employment level has been achieved
John Maynard Keynes
It is a phenomenon of continuous increasein general price levels in a given period.
It is measured by taking the percentagechange in the price index.
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Important characteristics
Continuous: rather than one off process
Increases in general price levels: rather than prices of specific
goods
Demand pull Cost push
Aggregate demand higher than
aggregate supply
Major factors
Increase in money supply,
Government budget deficit,
Increase in export earnings,
Unemployment level remains
minimum
Cost of factors of production
increases supply reduces
aggregate demand remains same
Major impact
Unemployment level increases to
maximum
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Features of Aggregate demand & supply
Aggregate Demand refers tothe collective behavior of all
buyers in marketplace.
Aggregate Demand
0
20
40
60
80
100
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Real Output (Qty peryear)
Pricel
evel(Average
price)
Aggregate Supply is the realvalue of output producers are
willing & able to bring to
market at alternative price
levels.
Aggregate Supply
0
20
40
60
80
100
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Real Output (Qty per year)
Pricelevel(Average
price)
Effects
Real Balance Effect
Foreign trade
Interest rate effect
Effects
Profit Effect
Cost effect
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Factors causing demand / cost push
Inflation Factors Impact Explained
Demand
Pull
Real: Increase in Government
expenditure with no change in
tax receipts or vice a versa
Monetary: Decrease in
demand for money or Increasein supply
Increase in
consumption,
export, investment
Cost
Push
Originating from supply side,
increase in wage levels not
matched by productivity
increase in profit margins whoexercise market power
Monopolists / oligopolists
Supply shock inflation
increase in cost of raw material
or shortage due to natural
calamities
Increase in labor
cost per unit
higher cost of
living fall in realwages
0
20
40
60
80
100
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Real Output ( Qty per year)
0
10
20
30
40
50
60
70
80
90
100
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
Real Output (Qty per year)
Pricelevel(Averageprice)
X
A
B
P
Y
Q
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Types of inflation
Types Defined Impact
Modest Very low level of inflation (2% - 3%) Slow but steady growth
Creeping Increase in price levels are small & gradual
(5% - 10%)
Induces investments in
economy
Running Continuous creeping inflation withoutadequate monetary or fiscal control will lead
to running inflation (8% to 10%)
Reduce savings,
Hindrance to future
economic growth
Hyper of
galloping
When monetary authorities completely lose
control on running inflation it will lead to
galloping inflation
Increase in velocity of
circulation of money
Deflation Price decrease in some goods / servicesoverweigh increase in price of other goods /
services
Inflation becomes negative &
asset price tumbled (Eg
Japan in 1995)
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Inflation how measured
Wholesale PriceIndex WPI indicator designed to measure changesin price level of commodities in wholesale trade intermediaries
Consumer PriceIndex CPI is measured on the basis of changes inretail prices of selected goods & services (essential goods)
Producers PriceIndex PPI is a family of indexes that measures theaverage change over time in the selling prices received by domesticproducers of goods and services
As of now inflation is measured through WPI, The consumer price
index is the most commonly cited measurement of inflation. Withundue changes in inflation rate, the Indian Government is giving athought to switch over to a more realistic way of measuring inflationthrough PPI that would replace WPI
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Measurement of Inflation
Wholesale Price Index
(WPI)
Consumer Price Index
(CPI)
Producers Price
Index (PPI)Measures the different prices
of a basket ofcommodities
in the wholesale markets.
Made up of 98 - Primary
products; 19 - Fuel, Power,Lubricant products;318 -
manufactured products.
The office of economic
adviser (OEA) in the Ministry
of Industry compiles the WPI.
Started in 1942 with baseyear as 1939.
Frequent revision in the base,Present base year 1993-94.
As ofnow the inflation is
measured through
wholesale price index
The CPI reflects the cost ofliving of
a particular group in the population
Based on changes in retail prices
of selected goods and services
(essential goods) on which a
particular group of consumers spend
their moneySeveral consumer price indices
ForIndustrialWorkers : CPI-IW
(Basket of 260 products)
ForUrbannon-manualemployees
: CPI-UNME (Basket of 180
commodities)
ForAgricultural Labours : CPI-AL(Basket of 60 commodities)
Data is collected through family
budget surveys
Base year is changed every few
years to take care of tastes /
appearance of consumption basket.
PPI is a family of
indexes that measures
theaveragechange over
time in the selling prices
receivedbydomestic
producers ofgoods andservices
The target set of goods
and services included in
the PPIs is the entire
marketed output of
producers. The set
includes both goods andservices (imports
excluded)
The price collected for an
item included in the PPIs
is the revenue received by
its producer
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WPI/CPI/PPI critical analysis
Wholesale Price Index(WPI)
Consumer Price Index(CPI)
Producers Price Index(PPI)
WPImeasures the prices
ofboth inputs and outputs
with the inclusion of taxes
paidby producers
Available at frequent levels
continuous monitoring of
price levels are possible
Duration is usually 1 or 2
weeks
Services & non-tradable
commodities excluded
The price collected for an item
included in the CPI is the out-of-
pocket expenditure by a
consumer for the item. Sales andexcise taxes are included in the
price
The target set of items included
in the CPI is the set of goods and
services purchased for
consumption purposes by urban
households (including imports).
PPI requires only prices of
outputs excluding
intermediatecosts and
taxes
The PPI methodology
provides easily understood
data & transparent
methodology as a whole
process.
The PPI methodology
automatically factors in theeffects of inflation as well as
the effects of changes in
wages and/or prices.
drawback in PPI is its hugedependence on the quality of
data voluntarily provided by
the respondents
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Weighting diagram of WPI & CPI
WPI Weight
All commodities 100.00
Primary Products 22.02
Food Articles 15.04
Paan, Supari, Tobacco 3.15
Fuel Group 14.23
Coal Mining 1.75
Housing 8.67
Manufactured products 63.75Food Products 11.54
Miscellaneous 16.36
Basic Metals 8.34
CPI Weight
All commodities 100.00
Food 57.00
Non-Food articles 6.14
Minerals 0.48
Fuel & Light 6.28
Mineral oils 6.99
Electricity 5.48
Clothing, Bedding 8.54Textiles 9.80
Chemicals 11.93
Others 21.62
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CPI status of India
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Consumer Price Index across Globe
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Inflation Level across developing countries
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Phillips curve
British Economist A W Philips pioneered the relationship between therate of employment and rate of wage increases
Important findings:
Inverse relationship : when wage rate rises low unemployment& vice a versa
Wages increase not matched by increase in labour productivityconverted into increase in price level
Organized labor can cause autonomous increase in wage rates inexcess of increase in productivity
The link between price changes and employment goes beyond the
dynamics of the labour markets.
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Economic Impact of Inflation
Effect of Inflation on the distribution of Income &
Wealth Different income groups of society negative effect more on
fixed income groups
Debtors & creditors debtors gain / creditors loose
Producers - gain
Investors equity investors gain / fixed income security investors
loose, Reduction in the real value of investment
Erosion of purchasing power
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Effect of inflation -------- contd..
Positive effects Adverse effects
Mild inflation
stimulates production &
lead to near full employment
encourages capital
investments
Hyperinflation Adversely affect
production
Decreasing purchasing
power
Discourages people from
saving
Hoarding of stock reducing supply & lead to
black marketing
Production shifts from
consumer to luxury goods.
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How can we control Inflation
Dontworry. I
think I canfix it
This graphis terrible!
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Strategies by Government / RBI /FM to
control inflation
Monetary Measures
Monetary Policy (money supply, credit control and bank rate)
Fiscal Measures
Public expenditure (increase / reduction)Taxation (higher taxes & duties on luxurious goods)
Public borrowing and debt (introduce special savings program
to divert consumption into savings)
Other Measures
Price control and rationing
Wage policy
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The Life cycle of Inflation
Overheating inflation growth
Output Inflation
Recession-Stagflation
Output Inflation Recession-Deflation
Output Inflation
Recovery-Non inflationary growth
Output Inflation
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Summary
Inflation is one important economic variable which is playing anever-expanding role in the decision making process of business,industry and government
Inflation affects real income tax liabilities in two ways.
It erodes the real values of fixed deductions.
It moves a tax payer in a high tax bracket. Low income groups
suffers more than high income groups during inflation "Containing inflationary expectations would continue to pose a
challenge to monetary management," RBI annual report 2005-06.
Is there a trade-off between inflation and employment?
Can policy-makers generate more employment through adeliberate policy of inflation
CPI or PPI Does it have any effect in controlling the current trend in
inflation??
Inflation measured in terms of variation in wholesale prices was 4.92percent, as compared with 3.7 per cent a year ago
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References
Web sitesReserve Bank of India
Government of India : Labour Bureau
IMF working paper Sources of Inflation in
Developing countriesIIMA
India Policy Forum Meeting paper How applicableis Inflation Targeting Framework (ITF) for India
IC
IC
I Bank e-business sitehttp://ebusiness.icicibank.com/research/
Managerial Economics - Trivedi
Economics for Managers ICFAI
Economics Subject Notes
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Thanks for your patience
- Discussion -