Type of Inflation • Semi – Inflation – Keynes, so long as there

unemployed resources, the general price level

• Creeping – when the rise in prices is will not rise as output increases.
very slow like that of a snail or creeper.
• True-Inflation – Keynes, When the economy
• Walking – when prices rise moderately reaches the level of full employment,
and the annual inflation rate is a single increases in aggregate expenditure will raise
digit. the price level in the same proportion.
• Running Inflation – When Prices rise • Open inflation – Markets for goods or factors
rapidly like the running of a horse at a of production are allowed to function freely,
rate or speed of 10 to 20percent annum, setting prices of goods and factors without
it is called running inflation. normal interference by the authorities.
• Hyper Inflation – when prices rise very • Suppressed Inflation – When the government
fast at double or triple digit rates from impose physical and monetary controls to
more than 20 to 100% per annum or check open Inflation, it is known as repressed
more, it is usually called Runaway or or suppressed inflation.
galloping inflation.
 Inflation is a quantitative economic measure of a rate of change in prices of selected
goods and services over a period of time. Inflation indicates how much the average price
has changed for the selected basket of goods and services. It is expressed as a percentage.
Increase in inflation indicates a decrease in the purchasing price of the economy.

Demand – pull Inflation

Cost – push Inflation

Built – in Inflation
Demand – Pull Inflation
S1

E1
P1

Price Level D1

E
P
D
S

O Yf
Demand and Supply
 Cost – Push Inflation
• Rise in Wages – They press employers to grant wage increases considerably in excess of increases
considerably in excess of increases in the productivity of labour, thereby raising the cost of
production of commodities.

• Sectoral Rise in Prices - In many cases, their production such as steel, raw materials, etc.. Are
used as inputs for the production of commodities in other sectors.

• Rise in Prices of Imported Raw Materials – Since raw materials are used as inputs by the
manufacturers of the finished goods, they enter into the cost of production of the latter.

• Profit – push Inflation - In a economy in which so called administered price abound there is at
least the possibility that these prices may be administered upward faster than cost in an attempt to
earn greater profits. To the extent such a process is wide – spread profit – push inflation will result.
 • Where S1 S is the supply curve and D is the
S demand curve. Both interest at E which is the full
employment level OYf, and the price level OP is
determined.

E1 • Given the demand as shown by the D curve, the

P1 supply curve S1 is shown to shift to S2 as a result of
Price Level

cost – push factors.

S2
P E • It interest the D curve at E1 showing rise in the
price level from OP to OP1 and fall in aggregate
D output from OY f to OY1 level
S1

O Y1 Y
Demand and Supply f
 CAUSES OF INFLATION
Factors Affecting Demand
Increase in Money Supply Deficit Financing

Increase in Disposable Income Expansion of the Private Sector

Increase in Public Expenditure Black Money

Increase in Consumer Spending Repayment of Public Debt

Cheap Monetary Policy Increase in Exports.

 Factor Affecting Supply

❖ Shortage of Factors of Production ❖ Increase in Exports

❖ Industrial Disputes
❖ Lop-sided Production

❖ Natural Calamities
❖ Law of diminishing Returns
❖ Artificial Scarcities.
❖ International Factors.
 Measures to Control Inflation
Monetary Measures Fiscal Measures
✔ Credit Control ✔ Reduction in Unnecessary
Expenditure
✔ Demonetisation of Currency
✔ Increase in Taxes
✔ Issues of New Currency
✔ Increase in Savings

✔ Surplus Budgets

✔ Public Debt
 Other Effects
❖ To Increase Production – if there is need, raw materials for such products may be imported
on preferential basis to increase the production of essential commodities.

❖ Rational Wage Policy - To control, this the government should freeze wage, incomes,
profit dividends, bonus etc..

❖ Price Control – Price control means fixing an upper limit for the prices of essential
consumer goods.

❖ Rationing – Its aims at distributing consumption of scare goods so as to make them

available to a large number of consumers.
 Effects of Inflation
On Distribution of Income and Wealth
Debtors and Creditors - When Prices rise the value of money falls. Though
debtors return the same amount of money but they pay less in terms of good and
services.
Salaried Persons - Salaried workers such as clerks, teachers, and other white
collar persons lose when there is inflation.
Wage earners – In this way, they may be able to protect themselves from the bad
effects of inflation. But the problem is that there is often a time – lag between the
raising of wages by employers and the rise in prices.
Fixed Income Group – The same is the case with the holders of fixed
interest-bearing securities, debentures and deposits.
Equity Holders or Investors – As profits increases, dividends on equities also
increase at a faster rather than prices.
Effects on Production:
Misallocation of Resources Hoarding and Black-marketing

Changes in the system of Reduction in Savings

transactions.
Hinders Foreign Capital
Reduction in Production
Encourage Speculation.
Fall in Quality
Other Effects
Government

Balance of Payment

Exchange Rate

Collapse of the Monetary System.

Social

Political
 DEFLATION
Deflation is a general decline in prices for goods and services,

typically associated with a contraction in the supply of money and

credit in the economy. During deflation, the purchasing power of

currency rises over time.

 Causes
There are two big causes of deflation: a decrease in demand or growth in
supply. Each is tied back to the fundamental economic relationship between supply and
demand. A decline in aggregate demand leads to a fall in the price of goods and services
if supply does not change.

• Monetary policy: Rising interest rates may lead people to save their cash instead of
spending it and may discourage borrowing. Less spending means less demand for
goods and services.

• Declining confidence: Adverse economic events—such as a global pandemic—may

lead to a decrease in overall demand. If people are worried about the economy or
unemployment, they may spend less so they can save more.
Consequences of Deflation
• Unemployment:- As prices drop, company profits decrease, and some companies
may cut costs by laying off workers.

• Debt:- Interest rates tend to go up in periods of deflation, which makes debt more
expensive. Consumers and businesses often decrease spending as a result.

• Deflationary spiral. This is a domino effect caused by each overlapping piece of

deflation. Falling prices may result in less production. Less production may lead to
lower pay. Lower pay may result in a drop in demand. And a drop in demand may
cause increasingly lower prices. And on and on. This can make a bad economic
situation worse.
Controlling Deflation
• Boost the money supply. The Federal Reserve can buy back treasury securities to
increase the supply of money. With a greater supply, each dollar is less valuable,
encouraging people to spend money and raising prices.

• Make borrowing easier. The Fed might ask banks to boost the amount of credit
available or lower interest rates so people can borrow more. If the Fed lowers the
reserve rate, which is the amount of cash commercial banks must have on hand,
banks can loan out more money. This encourages spending and helps raise prices.

• Manage fiscal policy. If the government bumps up public expenditures and cuts
taxes, it can boost both aggregate demand and disposable income, leading to
more spending and higher prices.
 An increase in the supply of goods and services in an economy typically results

from technological progress, the discovery of new resources, or an increase in

productivity. Consumer’s purchasing power increases over time and their living

standards rise as the increasing value of their wages and business incomes allow them

to purchase, use and consume more and better quality goods and services. This is an

unambiguously positive process for the economy and society as a whole.

 Stagflation
Stagflation is a new term which has been added to economic literature in the

1970s. The word “stagflation” is the combination of stag plus flation, taking ‘stag’

from stagnation and ‘flation’ from inflation. Thus it is a paradoxical situation where

the economy experiences stagnation or unemployment along-with a high rate of

inflation. It is, therefore, also called inflationary recession. The level of stagflation is

measured in the US by the “discomfort index” which is a combination of the

unemployment rate and the inflation rate measured by the price deflator for GNP.
 Recession and Inflation
• Governments respond to recessions through expansionary monetary and fiscal policies.
That is, they pump more money into the economy. More money means cheaper money.
Businesses are encouraged to borrow, grow, and hire. Consumers use credit more and
consider major purchases.

• Inflation requires the opposite response. The government restricts the supply of money
in the system in order to make it more expensive to borrow. Businesses and consumers
borrow less and spend less. The overall economy slows down. With demand declining,
prices stop rising.
• They accentuate inflation, raise wages and prices. As a result, the

real quantity of money declines, interest rates rise and investment

declines via the Pigou effect, making exports dearer and imports

attractive, and domestic output and employment decline. They lead

to stagflation.
• where employment is measured on the
horizontal axis and the price level on the
vertical axis. The initial equilibrium is at
E where the demand curve D intersects
the supply curve S and the price level is
OP and the employment level is ON.
When the aggregate supply is reduced
due to any of the factors mentioned
above, the supply curve S shifts to the
left at S1. The new equilibrium is at
E1 where S1 intersects the D curve. Now
the price level rises from OP to OP1 and
the level of employment declines from
ON to ON1.
Measures to Control Stagflation
This policy reduces the level of employment further to
ON’ and at the same time lowers the price level from OP1 to
OP. Thus such a policy tends to increase unemployment by
N1N’ and reduces inflation by P1P. Thus it fails to control
stagflation. On the other hand, if expansionary demand
managed monetary and fiscal policies are adopted, they will
raise the aggregate demand so that the new demand curve
D2 cuts the supply curve S1 at E2 at the old employment level
ON.

This raises employment from ON1 to ON but increases the

price level to OP2. Thus such a policy also fails to control
stagflation because it generates more inflation combined with
higher employment.