INFLATION

Group member Vinita Kadam Amit Singh Amit Kumar Desai Kartik Mehta Mitul Vora Paras Haria Rahul Sharma Ravi Vyas Ramchandra Suthar

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INFLATION

Definition:

Inflation can be defined as a rise in the general price level of goods and services and therefore a fall in the value of money. That means the purchasing power of your ‘money’ decreases.

Example: Price of 1KG rice: Rs 20 as on December 2009 If the inflation raises 10% annually (i.e. throughout

the year is 10%) Then the price of 1KG rice after 1 year (i.e. on 31st

December 2010) will be Rs 20 + (10% of 20) = 20 + 2 = Rs 22.

In other words, you can’t buy the same 1 KG rice with your Rs 20 money anymore, which you could buy in year 2009. I.e. purchasing power of your ‘money’ got reduced.

How Inflation is Calculated? There are two methods to calculate inflation -1.Wholesale Price Index (WPI)2.Consumer Price Index (CPI)

1. Wholesale Price Index (WPI): WPI is the index that is used to measure the change

in the average price level of goods traded in wholesale market.

In India, a total of 676 commodities data on price level is tracked through WPI which is an indicator of movement in prices of commodities in all trade and transactions.

The 676 commodities are divided into different groups & sub groups. Each commodity has some weightage in the WPI index. Below are the weightages of commodities group wise:

ITEMS Weightage

Primary Articles 20.1%

Fuel & Power 14.9%

Manufactured Products 65%

Formula:WPI of end of year – WPI of beginning of year X 100 WPI of beginning of year

Example:WPI on Jan 1st 1980 is 106.09 and WPI of Jan 1st

1981 is 109.72 then inflation rate for the year 1981 is,

= (109.72 – 106.09) x100 =3.42% 106.09 So the inflation rate for the year 1981 is 3.42%.

2.Consumer Price Index (CPI)

CPI is a statistical time-series measure of a weighted average of prices of a specified set of goods and services purchased by consumers. It is a price index that tracks the prices of a specified basket of consumer goods and services, providing a measure of inflation.

Most developed countries (UK, US, JAPAN and CHINA) use the Consumer Price Index (CPI) to calculate inflation.

DIFFERENCE BETWEEN WPI AND CPI

Wholesale Price index (WPI) Consumer Price Index (CPI)

WPI is available on weekly basis.

CPI is available on a monthly basis.

WPI contains commodities which are not even consumed by consumers. Example: Coarse grains that go into making of livestock feed.

CPI contains set of goods purchased and consumed by consumers.

WPI is measured in terms of price increase for the producers and traders.

CPI is measured in terms of price increase for the end consumer.

CHOICE OF A BASE YEAR In determining the base year for any index number, a

set of well-known criteria is followed. These include:a. The base year should be a normal year, i.e., a stable

year in respect of economic activities like production, trade, etc.

b. It should not suffer from business cycles;c. Availability of reliable price data for the selected

year.d. The base year should be as recent a year as possible

so that by the time revised series of items and their prices are released, it should not have outlived its utility.

WHY 2004-05 SELECTED AS NEW BASE YEAR? The Annual Survey of Industries (ASI) data is the

primary source for the selection of the product basket and derivation of product level weights for the manufacturing group of the WPI series.

The availability of the latest ASI data for the year 2004-05 was one of the major factors for considering 2004-05 as the base year for the new WPI series.

The year 2004-05, being a relatively recent year, the task of collection of backlog price data from this year onwards was expected to be more manageable.

Furthermore, it was a normal year, free from any major economic upheaval.

Recent Changes in WPI

ITEMS Base Year (OLD 1993-94)

Base Year (NEW 2004-05)

Primary Articles 22% 20.1%

Fuel & Power 14.2% 14.9%

Manufactured Products 63.7% 65%

WHY INDIA USES WPI?

Finance ministry officials point out that there are many problems from shifting from WPI to CPI model.

First of all, they say, in India, there are four different types of CPI indices and that makes switching over to the Index from WPI fairly ‘risky and unwieldy.’

The four CPI series are:

1) CPI Industrial Workers

2) CPI Urban Non-Manual Employees

3) CPI Agricultural labourer’s

4) CPI Rural labour.

Secondly, officials say the CPI cannot be used in India because there is too much of a lag in reporting CPI numbers.

The WPI is published on a weekly basis and the CPI, on a monthly basis.

And in India, inflation is calculated on a weekly basis.

TYPES OF INFLATION Demand-Pull Inflation

Demand-pull inflation occurs when there is an increase in aggregate demand, categorized by the four sections of the macro economy - households, businesses, governments and foreign buyers.

Cost-Push Inflation

o Aggregate supply is the total volume of goods and services produced by an economy at a given price level. When there is a decrease in the aggregate supply of goods and services curtail from an increase in the cost of production, we have cost-push inflation

OTHER TERMS RELATED TO INFLATION

Hyperinflation

.

Stagflation

Deflation

Definition - Hyperinflation Hyperinflation is inflation that is very

high or "out of control",

A condition in which

prices increase rapidly

as a currency loses

its value.

CAUSE OF HYPERINFLATION

A hyperinflation is caused by a

massive production of money

Excess printing of paper

currency

CAUSE OF HYPERINFLATION

Imbalance between the

supply and demand for

money

Effect Of Hyperinflation Positive effect

1. Reallocation Of Wealth

Negative Effect

1. Decrease In Commercial Activity

2. Rapid Increase In The Cost Of Imports

3. Frightening effect on the overall banking sector

Definition of Stagflation

Stagflation is the situation when both the inflation rate and the unemployment rate are high.

Stagflation is a difficult economic condition for a country, because inflation and economic stagflation are occurring simultaneously

Cause of Stagflation

Effect of Stagflation

1 . Companies cannot raise their prices

2. High retention rate

Definition of Deflation

Deflation is a decrease in the general price level of goods and services.

Deflation occurs when the annual inflation rate falls below 0% (a negative inflation rate)

Cause of Deflation

Money supply

Supply of goods

Demand for goods

Demand for money

Effect of Deflation

Positive Effect

1. The improvement of production efficiency

Negative Effect

1. Discourages both investment and

expenditure

2. Velocity of money

CAUSES OF INFLATION

There are various factors which causes inflation in the economy which is as follows-

Monetary Factors Expansion of Money SupplyIncrease in Disposable IncomeIncrease in Consumer SpendingDevelopment and Non-Development

Expenditure Indirect TaxesDemand for Foreign Commodities

Cont…

Non-monetary Factors  

Rising Population

Natural Calamities

Speculation and Black Money

Unfair Practices by Monopoly Houses

Bottlenecks and Shortages

Cont…

Structural Factors.  

Capital Shortage

Infrastructural Bottlenecks

Limited Efficient Entrepreneurs

Lack of Foreign Capital

Imperfections of the Market

Effects Of Inflation

On Production

Stimulating or Favourable Effect

Disastrous or Unfavourable Effects

On income Distribution

Farmers Gain In Inflation

On consumption and Welfare

Reduce the economic welfare of the fixed

Income group

o On Foreign Trade

Balance of payments.

o On Manufactures

Repayment of money.

On Social and Political EffectsThe antisocial elements get rewarded and the

masses suffer during inflation. Inflation disrupts social life by favouring rich and

black market. The standard of business morality goes down

during inflation. People lose faith in democratic government due

to inflation.

On Investment

o Less Savings

o Lower real returns

MEASURES TO CONTROL INFLATION

The Various measures to control inflation are:

1.Monetary Measures

2.Fiscal Measures

3.Other Measures

1. Monetary measures

The monetary measures which are widely used to control inflation are divided into-

a) Traditional Measures

Bank rate policy

Variable Reserve Ratio

Open market operation

Repo rate

Reverse repo rate

b) Non-Traditional Measures

Statutory Liquidity ratio

Selective credit controls

Moral suasion

Credit authorization scheme

2. Fiscal Measures

Fiscal measures to control inflation include taxation, government expenditure and public borrowings. The government can also take some protectionist measures (such as banning the export of essential items such as pulses, cereals and oils to support the domestic consumption, encourage imports by lowering duties on import items etc).

The principal fiscal measures are – (a) Reduction in Unnecessary Expenditure: The government should reduce unnecessary

expenditure on non-development activities in order to curb inflation.

(b) Increase in Taxes: To cut personal consumption expenditure, the rates

of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be too high as to discourage saving, investment and production.

(c) Increase in Savings: Another measure is to increase savings on the part of the

people so that their disposable income and purchasing power would be reduced. For this the government should encourage savings by giving various incentives.

(d) Public Debt: In addition, the government should stop repayment of

public debt and postpone it to some future date till inflationary pressures are controlled. Instead, the government should borrow more to reduce money supply with the public.

3. OTHER MEASURES

(a) To Increase Production (i) The government should encourage the

production of essential consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.

(ii) All possible help in the form of latest technology, raw materials, financial help, subsidies, etc. should be provided to different consumer goods sectors to increase production.

(b) Price Control: Price control and rationing is another measure of direct

control to check inflation. Price control means fixing an upper limit for the prices of essential consumer goods.

(c) Rationing: Rationing aims at distributing consumption of scarce

goods so as to make them available to a large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar, kerosene oil, etc. It is meant to stabilize the prices of necessaries and assure distributive justice.

REASONS FOR HIGH FOOD INFLATION Food Prices have become one of the most important topics in India over the last 2 years.

Deficient Monsoon season in 2009 was the primary cause of a sharp rise in Food Prices leading to Food Insecurity for a majority of the India.

Lower agricultural growth in India compared to the much faster GDP growth.

Wastage is another important problem, leading to shortage. Production we have raised, but so much is wasted because we still are a laggard when it comes to state of the art storage facilities.

Buffer stock not released on time even after knowing that there is a shortage.

The high food price inflation is having a significant impact on the Indian consumer in general and the Indian middle class in particular. The chart below gives the way the Indians spend.

It is estimated that India loses INR 58,000cr worth of agricultural food items due to lack of post harvesting infrastructure such as transportation, and storage facilities. If the

Government ensured proper storage facility, food inventory would have been more then sufficient leading to prices remaining under control.

INFLATION CHART

STEPS TAKEN BY GOVT Changes in Monetary Policy

The Following changes had been made to control inflation as shown in the data below:

Key Rates 3rd July2010 27th July 2010 16th Sep 2010 2nd Nov 2010

CRR 6% 6% 6% 6%

Repo rate 5.5% 5.75% 6% 6.25%

Reverse Repo rate 4% 4.5% 5% 5.25%

CURRENT RATESDifferent Rates Percentage

Inflation Rate 9.82%

Food Inflation 10.15%

Bank Rate 6%

Repo Rate 6.25%

Reverse Repo Rate 5.25%

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