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Price levelsUnit 06

RASHAIN PERERArashainperera@gmail.com077 059 37 52

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What is inflation?

The continuous rise in the general price levels in the economy over a period of time could be simply termed as “inflation”.

Inflation is defined as a sustained increase in the general level of prices for goods and services.

General price levels

The general price level is a hypothetical daily measure of overall prices for some set of goods and services (the consumer basket), in an economy or monetary union during a given interval (generally one day)

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Anticipated inflation In this case people anticipate or

forecast that future prices would rise or go up resulting inflation hence necessary precautionary steps or actions are taken at present.

However, all these precautionary measures would be temporary solutions for inflation

These temporary solutions are termed as “indexation”

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Indexation

This is a temporary solution taken by people in situations of inflation

Here people try to influence for the changes in real variables such as taxation, wages, interest rates etc in order to net off negative effects of inflation

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Unanticipated inflation

Inflation that arise due to temporal factors.

E.g. change of government, Instant natural destructions, war, recession

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Moderate-inflation less than 10% Double digit inflation-10%-99% Hyper inflation/3 digit inflation-inflation

more than 100% Creeping/mild inflation- a small rise over a long

period of time Stagflation- very high inflation, unemployment,

negative growth Suppressed inflation- inflation that is

controlled by the government

Types of inflation

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Core inflation- inflation rate calculated excluding food and energy items from NCCPI

Structural inflation- inflation built into an economy due to the governments monetary policy

Deflation- decrease in GPL over a period of time

Disinflation- is the slow down of the inflation rate being a positive figure

Types of inflation

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Walking inflation- This type of strong, or pernicious, inflation is between 3-10% a year. It is harmful to the economy because it heats up economic growth too fast. People start to buy more than they need, just to avoid tomorrow's much higher prices. This drives demand even further, so that suppliers can't keep up.

Types of inflation

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Galloping inflation- When inflation rises to ten percent or greater, it wreaks absolute havoc on the economy. Money loses value so fast that business and employee income can't keep up with costs and prices. Foreign investors avoid the country, depriving it of needed capital. The economy becomes unstable, and government leaders lose credibility.

Types of inflation

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A family who is receiving a subsidy in kind- positively

A family who is receiving a subsidy in monetary terms- negatively

An investor- positively An interest owner from a bank

deposit- negatively Debtor- positively Creditor- negatively

Parties affected by inflation

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Importer- positively Exporter- negatively Savings- negatively Investments- negatively Fixed income earners- negatively Variable income earners- positively

Parties affected by inflation

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Shoe-leather costs Menu costs Confusion costs Psychological costs/political costs Unemployment or negative growth Foreign investments being less

attractive Fall of exports High income disparity

Costs of inflation

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Demand pull inflation Cost push inflation

Causes of inflation

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Demand pull inflation Aggregate demand is a composition

of: Consumption Investment Government purchases Net exports

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Demand pull inflation is caused when these factors change so that aggregate demand increase i.e

Consumption increase Investment increase Government exp increases Exports increase Imports decrease

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AD

AS

Eq. price

New Eq. price

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Cost push inflation

This happens when cost of production increase

The increase in cost pull the supply curve upward or backward

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AD

AS

Eq. price

New Eq. price

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Policies implemented to reduce inflation.

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Monetary policy- increase in interest ratesSavings increase, investment decrease, consumption decrease

Fiscal policy- decrease government expenditure, increase taxesConsumption decrease, government expenditure decrease

Supply side policiesProducers are given subsidies, costs of production reduces

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Price indices are used to calculate price levels or inflation

It is important to study on absolute prices and comparative prices in this context

Calculating or measuring inflation

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Absolute prices

Changes in prices of an individual product

This helps to measure inflation

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Comparative prices

Comparing the changes in price of a commodity to another commodity

This helps to identify the resource allocation

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Price index

What is a price index? Average prices of a basket of selected

goods and services in a present period of time compared with a price of a base year could be simply termed as a price index

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Various price indices

GDP deflator Wholesale price index Colombo Consumers Price Index

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GDP deflator or implicit price index

(Nominal GDP/real GDP) x 100 (constant price GDP/current price

GDP) x 100

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Wholesale price index

This is prepared by CBSL to measure changes in prices at the primary sales level

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Colombo consumers price index

Basis CCPI(N)

Base yearCoverage

Target household unitsSize of household unitTotal number of itemsPrice collection centers

2006/07=100All urban divisions in Colombo

districtAll households in Colombo district4.437314

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RASHAIN PERERArashainperera@gmail.com077 059 37 52

Prepared by

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