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![Unfavourable Impacts
a) Fall in the real income of fixed-income groups: Real income means purchasing power
of money income [Real income = (money income ) / (price level).] Given the money
income of the fixed income groups, the real income will fall during inflation. Hence,
inflation affects workers, salaried People and pension-earners adversely.
(b) Inequality in the distribution of income : The profit incomes of businessmen and
entrepreneurs increasing during inflation while the real income of the common salaried
people declines. So, In equality in the distribution of income become acute during
inflation.
c) Upsets the planning process : When prices of goods, materials, and factor services
increase continuously, then more money has to be spent for the completion of any
investment project taken Up during any planning period. If more financial resources
cannot be raised by the Government (through savings or taxation), plan targets are to
be curtailed.
(d) Increase in speculative investment :If the price level rises at a fastrate, speculative
investment (say, purchasing shares, land, gems, etc. just for speculative purposes )may
increase in the economy for earning quick profits. These types of investments do not help
in the creation of productive Capital in the economy.](https://image.slidesharecdn.com/inflation-250514184111-164dfe52/75/Macro-Economics-Lecture-on-Inflation-complete-14-2048.jpg)
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Macro Economics : Lecture on Inflation complete
- 1.
- 4. About Inflation ?? • Inflation is persistent, continuous and substantial a rise in general level of price of goods and services in the country over period of time, • As the cost of goods and services increase, the value of a currency declines because the person won’t be able to purchase as much with that currency as they could have last month or year. • It has worst impact on consumers
- 5. Monetarists’ View Monetarists’ View:Monetarists assert that inflation has always been a monetary phenomenon. The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level. • This theory begins with the Fisher ’s equation of exchange: MV = PT
- 6. Keyenes’ View Inflation occurswhen price rises after the stage of full employment is reached in the economy, with no corresponding rise in employment and output.
- 7. Definition According to C.CROWTHER,“Inflation is State in which the Value of Money is Falling and the Prices are rising.” In Economics, the Word inflation Refers to General rise in Prices Measured against a Standard Level of Purchasing Power.
- 8. Mathematically, rate ofinflation can be expresses as
- 9. What are themain causes of inflation? Some inflationary pressures direct from the domestic economy, for example the decisions of utility businesses providing electricity or gas or water on their tariffs for the year ahead, or the pricing strategies of the food retailers based on the strength of demand and competitive pressure in their markets. A rise in the rate of VAT would also be a cause of increased domestic inflation in the short term because it increases a firm's production costs. Inflation can also come from external sources, for example a sustained rise in the price of crude oil or other imported commodities, foodstuffs and beverages. Fluctuations in the exchange rate can also affect inflation – for example a fall in the value of the pound against other currencies might cause higher import prices for items such as foodstuffs from Western Europe or technology supplies from the United States – which feeds through directly or indirectly into the consumer price index
- 10. Forms of Inflation True Inflation • It takes place after full employment of all factor inputs in an economy. • In a situation of full employment, the National output becomes perfectly inelastic. • Here more money will lead to higher prices and not more output. Semi-Inflation • A country may experience inflation arising from bottlenecks, even before full employment. • There maybe inflationary price rise in some sectors of the economy.
- 11. Types of Inflations Creeping inflation (1-4%) When the rate of inflation slowly increases over time. For example, the inflation rate rises from 2% to 3%, to 4% a year. Creeping inflation may not be immediately noticeable, but if the creeping rate of inflation continues, it can become an increasing problem. Walking inflation (2-10%) When inflation is in single digits – less than 10%. At this rate – inflation is not a major problem, but when it rises over 4%, Central Banks will be increasingly concerned. Walking inflation may simply be referred to as moderate inflation. Running inflation (10-20%) When inflation starts to rise at a significant rate. It is usually defined as a rate between 10% and 20% a year. At this rate, inflation is imposing significant costs on the economy and could easily start to creep higher.
- 12. Galloping inflation(20%-1000%) This is an inflation rate of between 20% up to 1000%. At this rapid rate of price increases, inflation is a serious problem and will be challenging to bring under control. Some definitions of galloping inflation may be between 20% and 100%. There is no universally agreed definition, but hyperinflation usually implies over 1,000% a year. Hyperinflation (> 1000%) This is reserved for extreme forms of inflation – usually over 1,000% though there is no specific definition. Hyperinflation usually involves prices changing so fast, that it becomes a daily occurrence, and under hyperinflation, the value of money will rapidly decline.
- 13. Favourable Impacts (a)Higher profits : Profits of the producers are generally favourably affected by inflation, because They can sell their products at higher prices. (b) Higher investment :The entrepreneurs and investors get added incentives to invest in productiveActivities during inflation, since they can earn higher prices. (c) Higher production : If productive investment grows during inflation, it would lead to higher Productionof various goods and servicesin the economy. (d) Higher employment and income :Increase in the output of different goods during inflation would Also mean increasing demand for various factors of production. So, it is expected that employmentAnd income opportunities willalso increase during inflation. (e) Possibility of higher income for the shareholders : During inflationary periods, if the companies earn Higher profits, they can declare dividends for their share-holders. Hence, the dividend income of The shareholders may also rise during inflation. (f) Gain for the borrowers :Inflation means a decrease in the value or purchasing power of money. If the rate of interest to be paid by the borrower is less than the inflation rate, the borrower will gain. • Because the real value of the money returned by the borrower is actually less than that of the Money borrowed earlier.
- 14. Unfavourable Impacts a)Fall in the real income of fixed-income groups: Real income means purchasing power of money income [Real income = (money income ) / (price level).] Given the money income of the fixed income groups, the real income will fall during inflation. Hence, inflation affects workers, salaried People and pension-earners adversely. (b) Inequality in the distribution of income : The profit incomes of businessmen and entrepreneurs increasing during inflation while the real income of the common salaried people declines. So, In equality in the distribution of income become acute during inflation. c) Upsets the planning process : When prices of goods, materials, and factor services increase continuously, then more money has to be spent for the completion of any investment project taken Up during any planning period. If more financial resources cannot be raised by the Government (through savings or taxation), plan targets are to be curtailed. (d) Increase in speculative investment :If the price level rises at a fastrate, speculative investment (say, purchasing shares, land, gems, etc. just for speculative purposes )may increase in the economy for earning quick profits. These types of investments do not help in the creation of productive Capital in the economy.
- 15. (e) Harmfulimpact on capital accumulation : If the price-rise becomes chronic, people prefer Goods to money (because the real value of money will fall in future).They also prefer immediate consumption to consumption in future. So, their desire to save is reduced. When both ability and willingness to save become less, a smaller amount of fund becomes available for further investment. • As a result, it creates a harmful impact on capital accumulation, since capital accumulation in an economy depends on the growth of investment. (f) Lenders will lose :We have already indicated that borrowers will gain during inflation. Forth is same reason, lenders will lose during inflation. Because, they are actually receiving an amount having Lowervalue(orpurchasing power)than before. • (g) Harmful impact on export income :If the prices of export items also increase during inflation, their Demand in the foreign market may fall. This leads to a fall in the export income of a country. Unfavourable Impacts
- 16. Inflationary Gap Inflationary Gapis the amount by which aggregate demand exceeds aggregate supply at full employment income level. Here, OY is the full employment income level OY’ is what the actual income level The amount by which aggregate demand(YF) exceeds aggregate supply(YE) is called the inflationary gap. YF – YE
- 17.
- 18. Demand-pull inflation Demandpull inflation occurs when aggregate demand is growing at an unsustainable rate leading to increased pressure on scarce resources and a positive output gap When there is excess demand, producers can raise their prices and achieve bigger profit margins Demand-pull inflation becomes a threat when an economy has experienced a boom with GDP rising faster than the long-run trend growth of potential GDP Demand-pull inflation is likely when there is full employment of resources and SRAS is inelastic
- 19. What are themain causes of Demand-Pull Inflation? Depreciation of the exchange rate Higher demand from a fiscal stimulus Monetary stimulus to the economy Fast growth in other countries
- 21. Cost-push inflation Cost-pushinflation occurs when firms respond to rising costs by increasing prices in order to protect their profit margins. There are many reasons why costs might rise: Component costs: Rising labour costs Expectations of inflation Higher indirect taxes A fall in the exchange rate Monopoly employers/profit-push inflation
- 23. Phillips curve A.W. Phillips(1958) showed a statistical relationship between the rate of growth of money wages and unemployment in UK 1861 – 1957. • Data seemed to suggest that fall in unemployment leads to rise in wage inflation. • Or fall in wage inflation leads to increase in unemployment. • This is an inverse relationship, and assumed to be stable.
- 24. The Relationship BetweenInflation and Unemployment The Phillips curve shows the inverse relationship between inflation and unemployment: as unemployment decreases, inflation increases. The Phillips curve relates the rate of inflation with the rate of unemployment. The Phillips curve argues that unemployment and inflation are inversely related: as levels of unemployment decrease, inflation increases. The relationship, however, is not linear. Graphically, the short-run Phillips curve traces an L-shape when the unemployment rate is on the x-axis and the inflation rate is on the y-axis.
- 25. Reasons for negativerelationship • As the economy reaches full employment, competition for labour drives up wage rate. • Employers will raise prices to maintain profits. • This is a type of “Cost Push Inflation”, • Workers’ real wages will not increase. So they will again demand a rise in nominal wage rates. • Again prices will increase, leading to a wage- price spiral
- 26. Keynesian explanation ofPhillip’s curve In the first panel on the left, AD increases, leading to increase in Q and employment. • AS also increases, as long as full employment is not reached. • So with increase in Q and N, prices also increase. • This is shown by the interaction of AS and AD curves as “a”, “b” and “c” points. In the second panel, taking the price levels P0, P1, and P2, • Draw the corresponding amounts of unemployment. • At P0, employment is low N0, so unemployment is high, U2. • As Ps increase, unemployment falls – U1,U0. Increase in inflation, unemployment decreases. • This gives the Phillip’s curve, with a negative slope, showing trade off between inflation and unemployment.
- 27. The Long-Run PhillipsCurve The long-run Phillips curve is a vertical line at the natural rate of unemployment, so inflation and unemployment are unrelated in the long run. There can be no trade-off between inflation and unemployment in the long run. Decreases in unemployment can lead to increases in inflation, but only in the short run. In the long run, inflation and unemployment are unrelated. Graphically, this means the Phillips curve is vertical at the natural rate of unemployment, or the hypothetical unemployment rate if aggregate production is in the long-run level. Attempts to change unemployment rates only serve to move the economy up and down this vertical line.
- 28. Natural Rate Hypothesis The natural rate of unemployment theory, also known as the non-accelerating inflation rate of unemployment (NAIRU) theory, was developed by economists Milton Friedman and Edmund Phelps. According to NAIRU theory, expansionary economic policies will create only temporary decreases in unemployment as the economy will adjust to the natural rate. Moreover, when unemployment is below the natural rate, inflation will accelerate. When unemployment is above the natural rate, inflation will decelerate. When the unemployment rate is equal to the natural rate, inflation is stable, or non- accelerating.
- 29. Assume the economystarts at point A and has an initial rate of unemployment and inflation rate. If the government decides to pursue expansionary economic policies, inflation will increase as aggregate demand shifts to the right. This is shown as a movement along the short-run Phillips curve, to point B, which is an unstable equilibrium. As aggregate demand increases, more workers will be hired by firms in order to produce more output to meet rising demand, and unemployment will decrease. However, due to the higher inflation, workers’ expectations of future inflation changes, which shifts the short-run Phillips curve to the right, from unstable equilibrium point B to the stable equilibrium point C. At point C, the rate of unemployment has increased back to its natural rate, but inflation remains higher than its initial level.
- 30. Stagflation This relationship, identifiedby Phillips, was seen as support for Keynesian policies. In the 1970’s the relationship between unemployment and inflation seemed to break down. The Oil crisis saw developed economies experienced low growth, and inflation and unemployment increasing at the same time.
- 31. Monetarists Milton Friedman, amonetarist economist developed a modified version of the original Phillips Curve. Friedman called his diagram the expectations- augmented Phillips Curve. The Phillips curve Friedman argued that in the long run the Phillip curve is vertical. The vertical long run Phillips curve is located at the natural rate of unemployment.