Theory of inflation

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Theory of Inflation
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Definition of Inflation 1.Inflation is
sustained rise in the general price level(
Average price of a set of selected goods and
services ) in an economy over a period of
time. 2. Inflation is sustained fall in the
purchasing power of moneygtgt When the general
price level rises,each unit of currency buys
fewer goods and services gtgtConsequently,
inflation reflects a reduction in the purchasing
power. 3. Inflation is sustained reduction in the
value of money 4. Inflation is also a phenomenon
of increase in money supply in economygtgtMonetary
Inflation.
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Types of Inflation Inflation is classified
according togt Rate of inflation Scope of
inflation Government intervention Causes of
inflation
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• Classification of inflation as per rate of
  inflation
• 1.Creeping Inflation
• It is also known as mild inflation or low
  inflation.
• The annual rate of general price rise is low
  gtgtBetween (23)
• If this rate or rise in price is continued,
  then it is considered good for the economy as
  producers and traders make reasonable profits
  which encourage them to invest more.
• This inflation is manageable.

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• 2.Walking Inflation
• It is also called trolling inflation.
• When the annual rate of rising prices is more
  than creeping inflation (i.e., 3-10 per cent),
  then it is called walking inflation.
• This inflation must be taken seriously as this
  is a warning for the occurrence of
  running/galloping inflation. If not checked, it
  can result in galloping inflation.
• When it rises over 4, Central Banks will be
  increasingly concerned.

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• 3.Galloping Inflation
• When annual inflation occurs for more than 10
  per cent and up to 50 per cent. it refers to
  galloping inflation.
• Due to this, businesses and employee's income
  cannot keep up with the costs and the prices.
• Even, foreign investors avoid such unstable
  economies for investment.
• This situation is also termed as hopping or
  running inflation.

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4. Hyperinflation It is an extreme form of
inflation where the prices rise at an alarming
high rate (i.e., more than 50 per cent every
month). Hyperinflation occurs when there is a
large increase in money supply In extreme
situations, the value of national currency
reduces to almost zero.
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Classification of inflation as per scope 1.
Comprehensive When prices of commodities rise
throughout the economy without any exception. 2.
Partial This inflation is sporadic nature. It
takes place when the prices of some goods rise
owing to a temporary shortage.
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Classification of inflation as per government
intervention 1. Open Inflation An inflation is
said to be open when the government takes no
steps to check the rise in the price level. 2.
Repressed Inflation When the government
actively intervenes to check the rise in the
price level.
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• Classification of inflation as per causes
• Demand Pull Inflation
• Cost Push inflation

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Demand Pull Inflation Full Employment Level
Full employment is an economic situation in which
all the available resources of the economy are
fully utilised. Demand pull inflation
Demand-pull inflation is when the aggregate
demand for a good or service is greater than
aggregate supply gtgtAllowing producers to raise
prices during full employment situation in the
economy.
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Inflationary Gap The Inflationary gap is a
situation which arises when Aggregate demand in
an economy exceeds the Aggregate supply at the
full employment level. To check demand pull
inflation arrangements should be made to expand
the supply in theeconomy.
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Cost Push Inflation There exists a situation
in an economy where inflation is fuelled up not
because of increase in aggregate demand but
mainly due to increase in the cost of producing
goods and services. The cost can be increased
mainly due to three factors gt Increase in wages
( Wage inflation ) Increase in profit margin (
Profit inflation ) Increase in prices of raw
materials ( Raw material push inflation ) gtgt It
is sometimes called supply shock inflation.
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Important terms related to Inflation
Stagflation The situation of rising prices
along with falling growth and employment (
Stagnation in economy ) is called as
stagflation. Disinflation Disinflation is a
situation in which the rate of inflation falls
over a period of time gtgtWhen the inflation rate
is falling from say 5 to 3. Reflation It is
a situation when inflation returns after a
deflationary phase indicating economic
recovery gtgtReflation policies can include
reducing taxes, changing the money supply and
lowering interest rates.
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• SkewflationIt means the skewness of inflation
  among different sectors of the economy some
  sectors are facing huge inflation, some are none
  and some are having deflation.
• Deflation It is the opposite of inflation
• gtgtDeflation refers to situation, where there is
  decline in general price levels
• Deflation occurs when the inflation rate falls
  below 0 (Negative inflation rate).

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Causes of inflation 1. Increase in Public
Spending 2. Deficit Financing of Government
Spending 3. Increased Velocity of money
Circulation 4. Population Growth 5. Hoarding
6. Genuine Shortage 7. Exports 8. Trade Unions
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9. Direct Tax Reduction 10.The imposition of or
rise in Indirect Taxes 11.Price-rise in the
International Markets 12.Devaluation.
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