Inflation

1. Inflation Radha. R

2. AGENDA • What is Inflation? • Degrees of Inflation • Types of Inflation • Cost Push Inflation • Types of Cost Push Inflation • Phillips curve – is unemployment inflated? • Inflation and your investments • Policies to tackle inflation • Conclusion • References

3. WHAT IS INFLATION? • Inflation is an increase in the overall level of prices. At what rate do the prices go up? • The rate at which the prices change is called the "rate of inflation". • When inflation goes up, there is a decline in the purchasing power of money • Example: If the price of Product X is Rs.100 this year and next year the price becomes approximately Rs.104 then the rate of inflation is 4% If the price of Product X is Rs.80 then after a year with a rate of inflation of 4% the price will go up to (80 x 1.04) = 83.2

4. DEGREES OF INFLATION There are three degrees of inflation: • Mild inflation: is a slow rise in price level of no more than 5 percent per annum. It is associated with a low level of unemployment and is during the upswing phase of a trade cycle. • Strato-inflation: the inflation rate ranges from about 10 percent to several hundred per cent • Hyper-inflation:is a very rapidly accelerating inflation which is 20 percent above. This usually leads to the breakdown of the country's monetary system as the existing currency may have to be withdrawn and a new one introduced

5. TYPES OF INFLATION • Demand-pull or excess demand Inflation: It occurs when the total demand for goods and services in an economy exceeds the available supply, so the prices for them rise in a market economy. E.g. War produces this type of inflation because demand for war materials and manpower grows rapidly • Cost-push inflation: This is caused when there is a supply shock. The best example to describe cost-push inflation is theoil shockin the 1970s. When the OPEC raised oil prices, the United States was forced to pay higher prices. Because oil is used in essentially every industry, this sent supply shockwaves throughout the United States, and overall prices went up, while wages paid stayed the same

6. Pricing power or Administered Price Inflation: It occurs whenever businesses in general decide to boost their prices to increase their profit margins. This occurs when the economy is booming and sales are strong. It might be called Oligopolistic Inflation (because it is oligopolies that have the power to set their own prices and raise them when they decide the time is ripe) • Sectoral Inflation: When various factors affect/hits a basic industry causing inflation. E.g. Steel or oil , that raises costs of the industries using steel or oil, and forces up prices there also, so inflation becomes more widespread throughout the economy, although it originated in just one basic sector.

7. COST-PUSH INFLATION • 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 stemming from an increase in the cost of production, we haveCost-push inflation. • Cost-push inflation basically means that prices have been “pushed up” by increases in costs of any of the four factors of production (labor, capital, land or entrepreneurship).

8. EXAMPLE • A company may need to increases wages if laborers demand higher salaries (due to increasing prices and thus cost of living) or if labor becomes more specialized. If the cost of labor, a factor of production, increases, the company has to allocate more resources to pay for the creation of its goods or services. To continue to maintain (or increase) profit margins, the company passes the increased costs of production on to the consumer, making retail prices higher.

9. HOW COST-PUSH INFLATION WORKS? • The equilibrium point is where the AS curve meets the AD curve. • The aggregate supply curve shifts left ie. From AS curve to AS2 because of the • increase in the cost.

10. TYPES OF COST-PUSH INFLATION • Wage Push Inflation: Situations where in a rapid increase in the workers’ wages causes the rate of inflation to increase. When workers’ incomes rise, they have additional money to spend. As those dollars go into the economy, the competition for goods increase and prices move upward. • Import Price Push Inflation: Higher import prices could result from a fall in the exchange rate. The higher cost of imported raw materials will raise the cost of production which may be passed on to the customers in the form of higher price.

11. Profit Push Inflation: This occurs when the prices are forced up as a result of which the firms raise their profit margin. • Tax-Push Inflation: Increases in income due to inflation can push people into higher tax brackets, a phenomenon known asbracket creep. In effect, inflation can increase people’s tax liability without any change in tax law.

12. PHILLIPS CURVE • The Phillips Curve is a relationship between unemployment and inflation discovered by Professor A.W.Phillips. The relationship was based on observations he made of unemployment and changes in wage levels from 1861 to 1957. • He found that there appeared to be atrade-offbetween unemployment and inflation, so that any attempt by governments to reduce unemployment was likely to lead to increased inflation.

13. PHILLIPS CURVE GRAPH This relationship however, in the 1970s appeared to break down as the economy suffered from unemployment and inflation rising together(stagflation). Stagflation -A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, or inflation, which is not a good situation for a country to be in.

14. INFLATION AND INVESTMENTS • Inflation is greatly feared by investors because it grinds away at the value of your investments. Example • Putting simply, Rs 45,000 today is not the same as Rs 45,000 in 1 or 10 years. It is crucial to include measures of expected inflation when calculating your expected return on investment (how much you make on your investment). • So, when you make an investment, make sure that your rate of return on the investment is higher than the rate of inflation in your country • Rate of Inflation – for the year 2006-07 is around5.5 – 6 %

15. POLICIES TO TACKLE INFLATION Demand Side Policy: • Fiscal Policy:refers to the expenditure a government undertakes to provide goods and services and to the way in which the government finances these expenditures. A government's taxation policy. Tax enables the government to raise revenue in order to provide public goods which would not otherwise be provided by the market, such as a police force, national defense, and so on. • Monetary Policy: refers to efforts to fight inflation or otherwise control or stimulate the economy by controlling the availability of spending money to company and consumers. Actions by the Federal Reserve to control the money supply

16. Supply side policy: Aim: To reduce the rate of increase in the costs. This is done by - • Restraining monopoly influences on the prices and incomes Policies to restrict the activities of trade unions, mergers and take-over. • Restricting policies to increase productivity Giving tax incentives, encouraging R & D

17. CONCLUSION Is inflation good for the economy? In an word , YES , But, it is essential that organizations like the Fed keep a close eye on its status and make the necessary adjustments.

18. REFERENCES Websites • http://searchwarp.com/swa87474.htm • http://www.yourdictionary.com/ • http://www.bized.co.uk/virtual/bank/economics/mpol/inflation/causes/theories4.htm • http://www.harpercollege.edu/mhealy/eco212i/lectures/fiscpol/fp.htm • http://www.investopedia.com/articles/05/012005.asp Books • Economics in Context : By Susan Grant, Chris Vidler • Economics - by Paul R. Krugman