It happens when we hear about rise and fall within currencies' purchasing power of goods and services, we think how the central banks such as Federal Reserve in United States and Reserve Bank of India control other commercial banks. We also observe that US sustain itself up to 3% inflation, while RBI tries to keep it between 2-6%.
India's Inflation within past decade is going to complete a cycle.
Inflation or decrement within purchasing power of goods and services of a currency, is one of the major factor within an economy, which have a lot of reasons and its own consequences or each type of inflation has its certain reasons and consequences. It is also regulated by monetary policies, and these monetary policies are controlled by the central banks of the respective economies.
It can be understood as increment in goods and services over a time period. It reduces the value of country’s currency. It can also be understood as the fall in internal or domestic purchasing power of money.
Inflation Rate= {(New Year Price- Base Year Price)/Base Year Price} X 100
Calculation of Inflation
It can be calculated within three tasks
- Choosing consumer market basket
- Calculating Price Index
- Calculating inflation
Market Basket: Market basket is a group of goods and services that are representative of purchase made over time but the quantity of items remains fixed.
Consumer Price Index (CPI): CPI refers to the price index (statistics that measures changes in prices over time) for “market basket” of goods and services, also called as cost-of-living index.
Formula:
Price Index = (New Year Price/Base Year Price) X 100
Price-Index: It is used in
- Converting GDP from nominal to real
- Tracking Prices and Consumers
- Evaluating Inflation
- Evaluating Cost of Inflation
For example: Let’s suppose that we have 5 products within our market basket, A-B-C-D-E.
Prices of A, B, C, D, E are 1 USD, 5 USD, 10 USD, 5 USD and 2 USD respectively at base year 2020. Here 2020 is our base year. So, our basket price at base year is 23 USD (1+5+10+5+2).
Now, let’s suppose that prices of A, B, C, D, E have become 1 USD, 6 USD, 10 USD, 5 USD and 3 USD respectively at next year 2021. And basket price at 2021 have become 25 USD.
Let’s calculate price index:
Price Index = (New Year Price/Base Year Price) X 100
Price Index = (25 USD/23 USD) X 100 = 108.70%
Calculation of Inflation at 2021
Inflation Rate = {(New Year Price- Base Year Price)/Base Year Price} X 100
Inflation Rate = {(25-23)/23} X 100 = 8.70%
Types of Inflation
Types of Inflation on the basis of cause
- Demand-Pull Inflation: an increase in the aggregate demand curve leads to an increase in the rate of inflation, when the aggregate demand for goods and services is greater than the aggregate supply. Demand Pull Inflation is defined as an increase in the rate of inflation caused by the Aggregate Demand curve. It is the most common cause of inflation.
- Cost-Push Inflation: This happens when demand remains steady while supplies are limited due to an external reason.
- Sectoral Inflation: Sectoral Inflation refers to the rise in prices occurring in different commercial sectors of a country. With the rise in prices of different raw materials, the prices of the finished products in diverse sectors increase simultaneously, leading to the initiation of Sectoral Inflation.
- Bottleneck Inflation: Bottle-neck inflation is the inflation that takes place when supply falls drastically and demand remains at same level. Which results excess demand in the economy as the supply cannot match with it and thus prices rise. This happens due to supply-side accidents, hazards or mismanagement.
Types of Inflation on the basis of pace
- Creeping Inflation: Circumstance where the inflation of a nation increases gradually, but continually, over time. This tends to be a typically pattern for many nations. Although the increase is relatively small in the short-term, as it continues over time the effect will become greater and greater. Creeping inflation or mild inflation can be said as inflation, which has an increment of up to 3% annually. The Federal Reserve (central bank or central authority of United States) consider that increase in inflation up to 2% or lower is good and it is good if a central authority is able to maintain inflation at 2%. Minimal inflation fascinates consumers to purchase goods and services, it indicates that they should buy now enough goods to avoid increments within future. Otherwise, they will have to purchase the same goods and services at a higher price instead of today’s lower one.
- Trotting Inflation: When prices rise moderately and the annual inflation rate is a single digit (3% - 10%), it is called walking or trotting inflation. If government does not mind the warning given by the trotting inflation, then it can turn into running inflation. Which can affect economy’s growth too.
- Galloping Inflation(inflation> or = to 10%): At rates equal to or greater than 10 percent, inflation is categorized as “galloping” and causes major economic problems. Within a short span of time, Money becomes less valuable, in such a way that necessary costs do not meet for both business and employees. Which increases economic issues due to lack of foreign capital investments within the economy. Investors become pessimistic towards the particular economy; they do not get a good return on investment due to birth of these economic issues.
- Hyper Inflation (Greater than 50%): The main reason behind hyper-inflation can be considered as excessive deficit spending (financed by printing more money) by the government of respective country, some economists also consider that if social breakdown introduces itself then it can be a reason of hyperinflation (not vice-versa) and they also believe that instead of economics, politics stands behind these social-breakdowns. In layman terms, due to domestic political conflicts, politicians within government do excessive deficit spending which leads hyper-inflation. Here, some various situations are given of a few countries:
a. United States Civil War in in the 1860s
b. 1920s Germany
c. Zimbabwe in 2000s
d. Venezuela in 2010
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