Concept of Inflation

economics
 
Welcome to revision series of UPSC SSC Part-5 
 
I have divided Syllabus of Economics (for UPSC and SSC exams)


  1. Economy: Introduction 
  2. Economy types 
  3. Economy sectors
  4. Salient features of Indian Economy
  5. Fiscal Policy (LPG also) and Taxation
  6. National Income – Economy Indicators- GDP, NNP etc.
  7. Balance of Payment
  8. Planning in India- Five year Plan
  9. International Organizations
  10. Banking in India and Monetary policy
  11. Agriculture
  12. Unemployment and poverty
  13. Inflation
  14. Budget
  15. Population 
  16. Transport and Communication(NH-1, 2 etc.)
  17. Important terms 
Yesterday, we discussed about Balance of Payment and we tried some MCQs on BOP and CAD in our fourth part of series namely ” [Revision Series] UPSC SSC (Part 4 of 8) Economics
Today, in [Revision Series] UPSC SSC (Part 5 of 8) Economics, we will discuss about:- Inflation
 
 
 
inflation

Theory #1: Demand Pull Inflation

In the economy, one of the big issues that gets a lot of press coverage is inflation. Inflation is a phenomenon in which the purchasing power of a currency decreases compared to the cost of goods. There are many different theories that aim to determine exactly what causes inflation. One of the more commonly used arguments by Keynsian’s is known as demand pull inflation. What exactly is demand pull inflation and why is it important?

Keynes- eugenics- demand pull inflationJohn Maynard Keynes

“Keynesian economics advocates a mixed economy — predominantly private sector, but with a significant role of government and public sector — and served as the economic model during the later part of the Great Depression, World War II, and the post-war economic expansion (1945–1973), though it lost some influence following the tax surcharge in 1968 and the stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused a resurgence in Keynesian thought.”

 

The term “demand pull inflation” is a Keynesian economics term. According to Wikipedia,
The basic idea behind demand pull inflation is that strong consumer demand helps drive inflation. When there are a limited number of goods in the market, and a large demand for those goods, the prices have to increase.
For a small scale example, imagine that there were 100 people who all wanted to buy big screen TVs but only 50 were available. In this scenario, only half of the people are going to end up with what they want. Because of this, everyone is going to be willing to pay a higher amount to get access to the limited resources. The company that owns the TVs can keep jacking up the price until they find a point that customers won’t pay anymore. Those last 50 big screen TVs might sell for much more than what the first batch of TVs sold for. Keynesian economics says that there are “too many dollars chasing too few goods”.
This type of inflation occurs when the aggregate demand for goods significantly outweighs the aggregate supply in the economy. This means that it happens on a large scale. It touches on the concept of scarcity. There are only so many resources in the world that can be used to create products. If the product or good were unlimited, then people probably would not be willing to pay very much money for it. Since it is limited, there has to be a certain point at which people will pay to gain access to it. As the resource or good becomes more scarce, people will pay more for it.

Theory #2: Cost Push Inflation

  1. Also known as supply side inflation.
  2. it means the cost of production has increased hence the price of products have increased.

What are the factors responsible?

 
 

Increased wages

 
1. Maruti is producing 1000 cars per month, but the union workers of Maruti go on a strike and demand higher salary.
2. Ultimately, Maruti agrees to the union demand, every worker will now get more salary. But of course the company never pays out of its own pocket and wants to keep the profit margin same so, the increased cost of car-production is always transferred to the customers. So the car that used to sell for two lakh rupees, will now sell for 2.17.

Increase in the tax

1. Finance Minister reads the newspaper headline – Indians have more mobile phones than toilets. So he thinks, why not increase the excise duty on the mobile phones and use that Revenue to give more funds under  “total sanitation campaign “ (TSC). That’ll help in building more toilets on the villages.

2. But of course, the CEOs of Nokia, Samsung or Motorola are not going to pay the money out of their pockets to finance the toilet building in Indian villages, they’ll pass the increased cost to the customers. MRP of Nokia Lumia is increased.
3. The cash in your hands is same as earlier, but the MRP has been increased by the supplier’s side. 
 

 

Reduced availability of raw material

 

 

Consider the case of onion

>>Bad weather= less production of onion or
>>the blackmarketeers are intentionally stocking up or hoarding onions for better prices in future.
>>Government declared attractive MSP (minimum support price) for Pulses (daal, Moong) so, farmers have shifted to producing those pulses instead of onions.
>>UAE businessman is paying higher prices for Indian onions, because of bad weather conditions there. So our middlemen, find it lucrative to export onions to UAE rather than to local vegetable market in city.
In all four cases, because the supply of onions is reduced, the restaurant owner will
  • A. Increase the per plate price of pau-bhaaji or
  • B. Keep the per plate price same as usual but reduce the quantity of onion given, so that you’ve to pay extra for the extra ‘supply’ of onion salad.
What happened? Supply of onion reduced, so restaurant owner’s input cost increase and he had to push the menu prices higher.
To get Higher profit margin
 

The Supply of rice is same, the disposable income in your wallet is same, but the restaurant owner wants higher profit margin, so he decreases the size of  every Idli , but your hunger remains the same, so you’ll order more idlies and end up paying higher bill.= Inflation.

1. The restaurant owner may not be the real-culprit here. Perhaps he is that daddy from the “demand pull pulsar bike” case: He had to increase the pocketmoney of his kid for that axe-perfume, SRK’s skin whitening cream and John Abraham’s sun-screen lotion.

2. That’s why he has to increase his profit margin to pay for those unnecessary products.Read our previous series of Economics
 
Also read:- 
 
 
 
Chapter Inflation MCQs
 

1. Demand-pull inflation may be caused by:

 An increase in costs
 A reduction in interest rates.
 A reduction in government spending.
 An outward shift in aggregate supply

2. Inflation:

 Always reduces the cost of living
 Reduces the purchasing power of a rupee.
 Always reduces the standard of living.
 Reduces the purchasing power of a pound.

3. An increase in injections into the economy may lead to:

 “An outward shift of aggregate demand and cost-push inflation”; “unilateral transfer made”
 “An outward shift of aggregate supply and demand-pull inflation”; “exports”
  “An outward shift of aggregate demand and demand-pull inflation”
 “unilateral transfer made”; “An outward shift of aggregate supply and cost-push inflation”

4. An increase in aggregate demand is more likely to lead to demand-pull inflation if:

 Aggregate supply is perfectly elastic
 Aggregate supply is unit elastic
 Aggregate supply is relatively elastic
 Aggregate supply is perfectly inelastic.

5. An increase in costs will:

 Shift aggregate supply
 Shift aggregate demand
 Reduce the natural rate of unemployment
 Increase the productivity of employees

6.The effects of inflation on the price competitiveness of a country’s products may be offset by:

 “exports of goods”
 “An appreciation of the currency”
 “A revaluation of the currency”
 ” Lower inflation abroad”

7. Menu costs in relation to inflation refer to:

 Costs of finding better rates of return
 Costs of money increasing its value
 Costs of altering price lists
 Costs of revaluing the currency

8. If we compile data in a country’s exports and imports of goods and services, its unilateral transfers, and its long-term capital account, the resulting net credit or net debit account would be called that country’s _____.

 Nominal wages are equal to expected wages
 Nominal wages are growing faster than inflation
 Real wages are back at long-run equilibrium level
 Inflation is higher than the growth of nominal wages

 
 
Answers
 
1.A reduction in interest rates
2. Reduces the purchasing power of a pound
3. An outward shift of aggregate demand and demand-pull inflation
4. Aggregate supply is perfectly inelastic
5. Shift aggregate supply
6. A depreciation of the currency
7. Costs of money increasing its value
8. Real wages are back at long-run equilibrium level

2 Comments

  1. KaVeEsH sHaRmA May 20, 2013
  2. Bharati December 6, 2014

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