GK Update: All about Inflation (Part I)

Dear Readers,

Inflation is a subject that always makes news and thus is very
important for your upcoming exams. In this series of articles, we will look into the
meaning of inflation and its types, factors affecting inflation, inflationary
trends in India, its consequences, etc.

Definition and causes

Inflation can be defined as a “sustained rise in the general
or overall level of prices of goods and services.” Thus, it can be understood
that as inflation increases, every rupee you have buys a smaller percentage of
good or service i.e. value of money reduces or your purchasing power reduces.

Inflation is viewed in conjunction with several other
phenomena because of its far-reaching effects on the economy. Deflation and
Disinflation are two terms used when there is a change in general price levels.
While the former refers to a fall in price levels, the latter denotes a slower
rate of inflation.

Inflation occurs mainly due to the following factors:

Increase in the total demand for goods and
services (demand-pull inflation)

Fall in the total supply of goods and services
(cost-push inflation)

1. Cost-Push
A decrease in total supply of goods and services due to
increased production costs (increase in employee salaries or raw materials,
increased tax rates) causes cost-push inflation. Despite maximised
productivity, companies cannot retain their profit margins in this scenario.
Thus, prices of the goods/services are increased for the consumer. In essence,
companies pass on the production costs to the consumers.

2. Demand-Pull
An increase in total demand for goods and services across
households, businesses, government and foreign buyers causes demand-pull
inflation. These constituents of the economy demand more goods than can be
produced by the economy. When supply cannot rise to meet demand, sellers will increase
prices, thereby causing inflation. Rise in government purchases, in money
supply, reduction in taxes (more discretionary income for households), are some
of the reasons for demand-pull inflation.

Types of Inflation

Let us now discuss some of the major types of inflation.

1. Creeping Inflation: Also
called low or mild inflation, this is when prices rise not over 3% a year. The
increase is slow and predictable vis-à-vis most other types. Creeping inflation
is considered to be economically beneficial as people expect prices to rise and
buy things. Increased demand as a result of low inflation drives economic
growth. For instance: In October 2014 in India, Wholesale Price Index (WPI) based
inflation was 2.38%, which later hit a zero level for the first time in five

2. Galloping inflation: Also
known as running, jumping or hopping inflation, this is characterised by double
or triple-digit inflation rate. During this, money loses value rapidly and
incomes cannot keep up with rising prices. Foreign investors steer clear of the
economy, thereby depriving it of required capital and instability rises further. During
the 1970s and 1980s many Latin American nations, including Argentina, Brazil, etc
had inflation rates in the range of 50%-700%.

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