MCom I Semester Business Environment Inflation Study Material Notes

MCom I Semester Business Environment Inflation Study Material Notes: Definitions of Inflation Intensity of Inflation Types of Inflations Causes of Inflations Effects of Inflation Measures to Control Inflation Exercise Questions Long Answer Questions Short Answer Questions Objectives Questions

BCom 2nd Year Advance Payment Tax Study Material Notes in Hindi

Inflation

Inflation is a popular occurrence in present day economy. Crowther has rightly observed, that inflation and deflation “are two much used and much abused terms.” So, first we should try to understand the meaning and definition of inflation. The meaning of inflation is associated with speedily rising prices which cause a decline in purchasing power of money. In other words inflation refers to an economic situation in which there is a constant rise in the price level.

Inflation Study Material Notes

DEFINITIONS OF INFLATION

There is no accepted definition of the term ‘inflation’. Different economists have offered different definitions of this term. Some of the important definitions of inflation are as follows:

1 According to Prof. Kemmeror, “Inflation is too much money and deposit currency in relation to the physical value of business being done.”

2. According to A.C Pigou, “Inflation exists when money income is expanding more than in proportion to income earning ability.”

3. According to Hawtrey, “The stage in which there is over issue of currency is called inflation.”

4. According to Webester, “Inflation is a stage when value of money and credit relative to available goods is resulting in a substantial and continuing in the general price level.”

Thus, by ‘inflation’ we mean a situation in which there occurs a continuous, presistent and undue increase in the quantity of money in proportion to buying power. Increase in money supply unaccompanied by a proportionate increase in the output of goods and services can be termed as inflation. Inflation depreciates the value of money and raises the general price level.

Inflation Study Material Notes

TYPES OF INFLATION

Inflation is of different forms. The important types of inflation are as follows:

1 Production based inflation: The fall of production creates disequilibrium in supply of and the demand for money. On the conditions of production, the demand for money depends. If production is less or there is rise in cost of production of Entrepreneurs are not ready to reduce the price of goods even when their cost of Production or Entrepreneurs are Not ready to reduce the Price of Goods even when their cost in reduced and Instead increase their Profits there is inflations .

2. Currency inflation : When the supply of currency increases in a count it results is corresponding increase in the prices of goods and services. When government creates more money by issuing more currency notes without pr sufficient gold reserves, this may result in a rising price level.

3. Peace time inflation : It mean inflation : It means rise in price level during peace time. Developing countries of the world have to spend a lot of money for undertaking many development and employment generation activities so as to bring forth speedy development in the economy. This type of inflation is very often the result of increased government expenditure on different development projects in the economy. An inflation resulting from such kind of economic programmes is termed as peace time inflation.

4. Open inflation and suppressed inflation : When the government does nothing to check the inflation, then it is open inflation. If an attempt is made by the government to check the inflation by introducing different measures, it is suppressed inflation.

5. Over investment inflation : When the entrepreneurs invest huge amount of capital, the prices of raw material and factor services increase rapidly. As a result price of goods becomes high. This situation is termed as overinvestment inflation.

6. Imported inflation : When the price of goods increases in domestic economy as a result of foreign trade, it is called as imported inflation.

7. Comprehensive inflation and sporadic inflation : If there is rise in prices only of some goods and services, it is ‘sporadic inflation.’ If there is rise in prices of most of the goods and services, it is comprehensive inflation.

8. Profit inflation : Due to new invention or some other causes, cost of production of goods falls, but prices are not allowed to be reduced and profits are increased. This position is known as ‘Profit inflation.’

9. Cost push inflation : When the cost of production rises and as a result, thereof, prices rise, the position is known as cost push inflation. The inadequacy of raw materials increases the prices of goods.

10. Credit inflation: When commercial banks adopt a liberalised lending, or when the rate of interest is reduced, it results in introducing of the credit money for more and more uses. As a result of which prices of goods and services rise. This situations is called credit inflation.

Inflation Study Material Notes

INTENSITY OF INFLATION

The inflation can be classified on the basis of the speed with which the prices increase in the economy. They are as follows:

1 Creeping inflation : By creeping inflation, we mean a slow increase in prices. This increase is so slow that the people may not feel the pinch. According to Prof. Keynes, “Amild increase in price levels is helpful for economic growth. A slow and steady rate of inflation provides a most powerful aid to the attainment of a steady rate of economic progress.” It has been pointed out that the price level rising approximately by 2 percent yearly come under creeping inflation.

2. Walking inflation : An increase in the rate of rise in prices at a pace faster than that of creeping rate of inflation is called walking inflation. The price level under walking inflation rises approximately by 5 percent yearly, investors are benefited in this situation.

3. Running inflation : A slow and steady rate of imitation in the initial stage culminates into a running inflation at a later stage when the purchasing power of money decreases, the burden of inflation is borne by the fixed income groups such as wage earners, government servants, pensioners etc, prices rise approximately by 10 percent every year. 30-50

Hyper inflation : A rate of increase in the prices at the fastest pace is termed as the hyper inflation. It denotes a state of affairs where wages and prices chase each other at a galloping speed. Rapid rising trend in prices results in greater discontentment and thereby loses the confidence of the people in the currency system prevalent in the country. This rapid erosion in the purchasing power of the currency causes wide spread alarm among the planners of the country. This type of information invariably occurs after the point of full employment. Under this type of inflation, the price level rises approximately by 16 percent or more every year.

The above mentioned four different types of inflation are explained graphically:

Periods (years) are presented and along OY-axis, the percentage increase in prices are shown. The lines OA, OB, OC and OD represent the different forms of inflation. OB represents walking inflation and similarly OC, and OD lines represent running and hyper inflation respectively.

Inflation Study Material Notes

CAUSES OF INFLATION

The inflation represents a situations when the supply of money is more than what is actually required. The inflation is represented by the conditions of demand and supply of money. The causes of inflation may be grouped under two heads. They are :

1 Causes of increase in demand : Increased purchasing powe increases the demand for goods and services. It includes the follow Increased purchasing power of people

(i) Increase in public expenditure : Under developed countries spe more and more money for the development activities. The reckless increase the government expenditure particularly on account of large interest payments, defence expenditure and various types of unwarranted subsidies has led large budget deficit which in turn ger All the countries, especially, the developing countries, have been adopting deficit

which in turn generates considerable inflationary pressure. financing for their development programmes and have been printing more paper currency. Deficit financing has been on the increase in many of the countries and on account of this, the quantity of currency notes in circulation increases and the state of inflation takes place.

(ii) Quantity of black money : Black money is unaccounted money in the hands of tax evaders, speculators, smugglers, hoarders, black marketeers etc. People with such money spend it lavishly which raises prices of goods and services in the market.

(iii) Tax-exemption : Tax-exemption provided by the government increases purchasing power of people. As a result prices of goods and services increase at a higher rate and the situation of inflation occurs.

(iv) Payment of public debt: When the government repays its old debts, it increases the purchasing power of people. This raises the market demand and contributes to price rise.

(v) Expansion of currency and credit money : When the government shows deficit in the budget and creates a new or additional money by issuing more currency notes, the purchasing power of people increases. Similarly when banks give more and more credit, more money flows into the market as a result of which inflation increases.

(vi) Increase in exports: When the government encourages exports with a view to earn foreign exchange, it follows with an increase in the price of goods within the country.

(vii) Population growth : Whenever, there is a spurt in the population increase of a country, the balance between demand and supply becomes unequal. If the rate of population growth is more than the growth of production, prices of goods rise rapidly. More people mean more demand for all kinds of goods and services which in the face of slow growing production, causes to prices rise.

2. Causes of lack in supply:Factors on the supply side generally operate through their effect on the cost of production, main factors on the supply side affecting prices are as follows:

(i) Lack of Factors of Production : When economy of a country lacks factors of productions such as labour, raw materials, electricity, shortage of capital goods etc. the supply of goods and services decreases and as a result of this inflation takes place.

(ii) Technological changes: Due to technical changes in a country, supply of anods and services decreases for a short period. As a result of it, condition of inflation occurs in the economy.

(iii) International causes : Inflationary pressure in one country affects another country. Slowly this inflationary pressure becomes the economy of another country. Slowly this Land scarcity of goods occurs. This creates the position of inflation.

 (iv) Trade policy : When the government imposes restrictions on the imported goods, then the supply of goods decreases and prices begin to rise. Similarly, if the protection policy of the government continues for a long time, the problem of inflation becomes serious.

(v) Natural calamity : Natural calamities like flood, drought, earthquake etc. badly affect the agricultural production. It will create inflationary conditions.

(vi) Commodity hoarding: Failure of crops always encourages big farmers and the wholesale dealers in agricultural products indulge in hoarding with the expectation that the prices of these commodities would rise. This behaviour of producers and middlemen, though not irrational and immoral according to the ethics of capitalism, is in clear conflict with the interests of the society. Hoarding, when production goes down in the country, aggravates scarcity conditions and pushes up the price level.

Inflation Study Material Notes

EFFECTS OF INFLATION

There is no doubt that a continuous rise in the general price level is injurious to social interest, it is dangerous in terms of current welfare and future development. Many aspects of day to day activities are influnced by the changes in the rate of inflation. When inflation continues for a long time and the rate of price rise remains unanticipated, it disrupts the society economically, morally, socially and politically. The effects of inflation can be discussed under the following sub-heads. These are as follows:

(I) Economic effects : Economists often argue that a mild dose of inflation is good for an economy. Traders, merchants, businessmen and speculators reap goods profit as a result of inflationary rise in price. Economic effects of inflation are as follows:

1 Effects on producers and traders : All traders, producers and speculators gain during inflation because of windfall profits. Follwing are the main causes :

(i) Increase in demand : At the time of inflation, demand for goods increases. Sellers keep those types of goods whose prices rise is much more than general level of price. Thus, the producing and trading classes gain enormously during an inflationary period.

(ii) Increase in employment: During the period of inflation new industires and business are established which provide more job opportunities.

(iii) Development of banking: During the period of inflation,bank deposits increase and banking develops rapidly.

(iv) Increase in income:Inflation increases production and employment opportunities and as a result of which income of people increases and raises the standard of livng.

(v) Economically dynamic: During inflation new industries new business start as a results all the factors of production are employed efficiently.

2. Effect on investors : Investors are mainly of two type:

(i) Effect on investors of fixed income : People with fixed income such as workers, government employees teachers etc. find that their money income is more or less fixed while the prices of goods and services are rising speedly. Inflation results in erosion of their purchasing power. They worst suffer in the inflation.

(ii) Effects on investors of uncertain income: Producers and traders whose income is uncertain, earn is uncertain, earn huge profit. The business classes make allround gains during the period of inflation, due to a time lag between the rise in production costs and rise in the price levels.

3. Effects on cultivators : Big farmers have benefited the most from the inflationary price rise. Big farmers, who had large marketable surplus, earned huge profits when prices of agrigultural products rose. The worst sufferer in the whole process have been the agricultural workers who are least organised in this country with no atlernative opportunities, their bargaining power is also very little.

4. Effects on consumers : The worst sufferers in an inflation are the consumers. Their income normally does not rise as much as the prices of goods and services go up. A sharp and persistent rise in general price level affects the economy adversely.

5. Effect on banking and insurance companies : During the period of inflation, banking and insurance companies flourish. More and more branches of banking and insurance companies are established.

6. Effect on labour class : During inflation period, working class also suffers. The price rise has not always been accompanied by upward revision of wage rates. The real wages of the various catagories of workers in terms of purchasing power are declined. The cause of this is the time-lag between the rise in price-level and rise in wages. Industrial workers and the government employees have powerful organisations to protect their interests.

Naturally, they have succeeded to some extent in getting money wage hike in order to off-set the erosion of their real wages.

(II) Non-economic effects : Non-economic effects of inflation are as follows:

1 Economic inequalities : When prices rise continuously increasing over a long period, inequalities of income and wealth increase. The producers, the agriculturists, the manufacturers and the traders gain at the expenses of salaried and working class. The rich becomes richer and the poor becomes poorer. Therefore, inflations is considered unjust.

2. Political effects : Whenever the price situation becomes grave in the country and the mass discontentment threatens the very existence of political system. Many groups of workers get organised in the trade unions. It creates a sense of frustration and distrust.

3. Increase in taxation : During the period of inflation, the government imposes high taxes on people to reduce the purchasing power of people. In this way, the fixed income groups bear excess of burden.

4. Moral effects : During inflation, the administration becomes slack; bribery and corrupt practices prevail, profiteering, black marketing etc. go on unchecked and a sort of artificial scarcity is created.

5. Hoarding: Inflation creates hoarding among the traders and consumers. The traders hoard stocks of essential goods to earn more and higher profit. Investment in real estates increases. Inflation invites business to seek profits a manipulation of markets rather than via efficient production. Inflation throws burden on those sections of the community who are not able the bear it. The producing and trading classes gain enormously during an inflationary period. It is, therefore, “economically unsound, politically dangerous, socially disastrous and morally indepensible.”

Inflation Study Material Notes

MEASURES TO CONTROL INFLATION

The government’s price policy has been to stablise prices. The serious political, economic and social consequences of inflation call for taking effective measures to control inflation. Inflation must be controlled before it is widely spread in the economy. The measures against inflation may be classified under various heads. They are as follow :

1 Monetary measures : These are the best measures to control inflation through adopting monetary measures by the central bank of the country. A number of monetary measures may be adopted to check inflation. Some of the measures are as follows

(i) Increase in bank rate : This measure is used by the central bank to control inflation. Bank rate is central bank’s lending rate which member banks must pay on their borrowing from the central bank against approved securities, A rise in bank rate shows that central bank’s monetary and credit control policy is being directed towards credit squeeze to control inflationary forces in the economy. In the inflationary situation, the central bank will raise its bank rate. The rise in the bank rate forces the banking system to re-examine its lending policies and to re-appraise the credit conditions.

(ii) Control on consumers loans : To check the inflation, the central bank controls the consumer loans. It regulates expenditure of consumers, in other words, when the loan for consumer goods becomes costly, the demand for consumer goods decreases and prices begin to fall.

(iii) Increase in cash reserve ratio : The central bank can also restrain excessive credit expansion by the commercial banks as part of its anti-inflationary monetary policy by raising the minimum legal cash reserves ratio to be kept by the commercial banks with it. A rise in the minimum cash reserve ratio raises the total amount of cash balances which the banks must keep against their deposits with the central bank. This action will force the banks to curtail their total advances.

(iv) Open market operations : The central government may sell government securities in the open market. The heavy sale of securities to the public and banking community by the central bank in public’s asset portfolio and cash reserves with the commerical banks. The fall in the cash reserves of the banks forces them to reduce their total advances. The indirect effect of open market sales of securities is seen in the rise of the interest rate.

2. Fiscal measures : Monetary policy alone cannot help in curbing the difficult problem of inflation. so, the anti-inflationary fiscal policy is pursued by the government. The important fiscal measures to check inflation are as follows:

(i) Balanced budged: During inflation, the government should avoid deficit financing as far as possible. The policy of increasing public revenue through taxation should be adopted.

(ii) Public debt: Public debt or the debt of the government may be managed in such a way that the surplus money in the country may be controlled. The government should avoid paying back any of its previous loans during inflation, so as to prevent an increase in the circulation of money.

(iii) Taxation : There should be steep increase in existing taxes and new taxes should be imposed on commodities. This measure would reduce the spendable income in the hands of people.

(iv) Control on public expenditure : As an anti-inflationary measures, government expenditure should be reduced. This will mean that the demand for goods and services will be further reduced. This policy of increasing public revenue through taxation and decreasing public expenditure is known as surplus budgeting. But there is one difficulty in this meausre. In the face of steadily growing public expenditure and increasing reliance on deficit financing, it is difficult to believe that the government has effectively employed all fiscal tools for curbing inflation.

3. Other measures: Other measures to check inflation are as follows:

(i) Overvaluation of currency: During inflation, the government should adopt the policy of overvaluation of currency. Overvaluation is fixing the value of its currency at a level higher than what it would be if there was no intervention in foreign exchange. If a country is suffering from inflation, the exchange value of the national currency will go down when exchanges are left free to move. The downward trend in home currency must be arrested by over-valuing the domestic currency, otherwise imports will become very dear and the exporters will have windfall profits.

(ii) Change in investment pattern : Mr. L.K. Jha had said that there was need to increase investment in basic essential goods which were scarce and costly. He pleaded for a judicious use of ragulatory instruments to achieve a shift in production from luxury goods to essential goods. Fiscal measures could be devised to reduce the profitability of non-essential commodities and make investment in essential goods more attractive. Curb on monetary expansion must be within the framework of continuous investment in agriculture and in those industrial products which were major elements in fixing the cost of living.

(iii) Control in income :By regulating the incomes of the different classes of society, inflation can be controlled. There are different methods of checking income such as-wage stabilisation, reduction in bonus, stop payment of dividends etc.

(iv) Increase in production: Another important anti-inflationary measure is to increase the supply of goods through increased production or increased imports. Production may be increased by shifting factors of production from the production of less sensitive goods to essential goods.

(v) Measures related to international trade: The non-monetary measure is the increasing imports and decreasing exports so as to increase the available supply of goods in short supply.

Inflation Study Material Notes

EXERCISE QUESTIONS

Long Answer Questions

1 What is inflation ? Explain in detail different measures to control it.

2. Define inflation and explain in detail its economic effect.

3. What do you understand by inflation ? Discuss the causes of inflation in detail.

4. Explain the various types of inflation.

5. “Inflation is state in which the value of money is falling or prices are rising.” Crowther. Explain the above statement.

6. Discuss fully the effects of changes in the value of money on the volume of production, employment and real incomes of the various sections in the community.

Short Answer Questions

1 What is inflation ?

2. What do you understand by demand pull inflation ?

3. What is cost push inflation ?

4. Which are the monetary measures?

5. What do you understand by quantity of black money? Objective Questions

(I) Select the correct alternatives :

1 Real meaning of inflation is :

(a) Price rise due to increased supply of money.

(b) Increase in price due to increased demand.

(c) Disequilibrium between money income and production.

(d) Constant and persistant rise in price.

2. “Inflation is always a monetary phenomenon.” Who said it?

(a) Irving Fisher

(b)J.M. Keynes

(c) Milton Freedom

(d) Benthenson.

3. Demand-pull inflation arises due to:

(a) Increase in production

(b) Increase in cost of production

(c) Increase in money income

(d) Increase in demand of money funds.

4. Who propounded the concept of Inflationary Gap’?

(a) Wickcell

(b) Keynes

(b) Milton Fredman

(d) A.W. Philips. com

5. Among following which is not the cause of inflation ?

(a) Increase in cost of production.

(b) To induce demand.

(c) Excess production.

(d) Excess money supply.

6. Among following which statement is not ture:

(a) Inflation increase in equality in distribution of income.

(b) Inflation increase level of employment.

(c) Inflation may be controlled by the monetary measures alone.

(d) Deflation is worse than inflation.

[Ans.(1) d, (2), (3) c, (4) b, (5), (6) c.]

Inflation Study Material Notes

(II) Write True or False :

1 Sometimes inflation is the result of natural causes.

2. Artificial inflation cannot be controlled by the government.

3. Demand for and supply of money may not be estimated accurately.

4. Increase in population does not increase the demand for goods and services.

[Ans. (1) True (2) False (3) False (4) False.

(III) Fill in the blanks :

1 The government issues …………….. to correct the deficit in budget.

2. With increase in the foreign exchange ……………. of money increases.

3. Supply of money increases from the increases in national income and ………..

4. Public expenditure is essential for ……

(Ans. (1) new curriencies (2) supply (3) monetisation of economy (4) economic development.]

Inflation Study Material Notes