Meaning of Inflation - MacroEconomics-BBA BBS BBM - TU note

Generally,  inflation  is  a  substantial  and  rapid  rise  in  the  general  price  level  which  causes  a  decline  in  the  purchasing  power  of  money.  When  the  general  price  level  rises,  each  unit  of  currency  buys  fewer  goods  and  services  than  before. Inflation is statistically measured in terms of percentage increased in the price index per-unit of time. But each and every rise in general price level cannot be termed as inflation in the true sense. To be inflation, the following conditions should be fulfilled:

1.      The price level is raising not the price of a single commodity.  

2.      The price rise must be continuous.  

3.      The price rise must be significant (large enough).  

Types/ Kinds of Inflation  

There are different types of inflation which can be classified as follows:  

1.     On the Basis of Speed

On the basis of speed, inflation is classified as follows: 

a.      Creeping inflation: 

 When the annual rate of inflation is up to 3 percent, it is  called  creeping  inflation.  It  has  no  negative  impact  on  the  economy.  It  creates positive effect on investment, production and employment. 

 b.      Walking inflation: 

When the rate of rise in price level is in the range of 3 to 7 percent per-annum or less than 10 percent, it is called walking inflation. It is  a  warning  signal  for  the  government  to  control  it  before  turns  into  running inflation. 

 c.  Running inflation: 

When the price level rises at a rate of speed of 10 to 20 percent  per  annum,  it  is  called  running  inflation.  It  affects  the  poor  and  middle  classes  people  adversely.  If  it  is  not  controlled,  it  turns  into  hyper  inflation.  

d.       Hyper inflation: 

When price level rises more than 20 percent per annum. It is called hyper inflation. This is the last stage of inflation which starts after the full-employment level is reached. Keynes consider this type of inflation as the true inflation.

2.     On the Basis of Inducement  

On the basis of inducement, inflation is classified as follows:

 a.      Wage induced inflation: 

When inflation occurs due to a rise in wages, it is called  wage-induced  inflation.  With  the  increase  in  wages,  price  level  also  rises.  

b.     Profit induced inflation:

 When the producers tend to mark-up their profit due  to  their  monopoly  position,  it  will  lead  to  profit  induced  inflation.  It  increase the cost of production, which in turn, pushes up the prices. 

 c.        Scarcity  induced  inflation: 

 When  the  supply  of  goods  and  services  does  not  increase  due  to  natural  calamities,  the  price  level  tends  to  rise.  Such  rises in price level is called scarcity-induced inflation. 

 d.       Deficit  induced  inflation: 

 When  a  government  covers  the  deficit  in  its  budget  by  creating  new  money,  the  purchasing  power  of  people  increases  without increase in production. This leads to a rise in the price level which is known deficit induced inflation.  

e.      Currency induced inflation: 

When the money supply exceeds the available output,  it  leads  to  rise  in  price  level.  This  is  called  currency  induced  inflation. 

 f.        Credit  induced  inflation: 

 When  price  level  rises  due  to  an  expansion  of  credit without increase in money supply, it is known as the credit induced inflation.  

g.       Foreign  trade  induced  inflation: 

 When  exports  of  a  goods  and  services  increase, there will be the shortage of goods and services in home country. It leads to rise in price in home country. Such rise in price level is known as foreign trade induced inflation.  

3.     On the Basis of Time  

On the basis of time, inflation is classified as follows:  

a.       Peace  time  inflation:  

Peace  time  inflation  refers  to  the  rise  in  price  level  during normal time period. This type of inflation is experienced in the less developed    economies    due    to    excessive    aggregate    expenditure    on    development  projects  which  have  longer  gestation  periods.  This  leads  to  rise in price level.  

b.     War time inflation: 

In the war time, unproductive government expenditure increases which in turn, price level rises. It is known as war time inflation. In  war  time,  output  does  not  increase  with  the  increase  in  government  expenditure. But demand for goods increases as a result price level rises. 

 c.        Post  war  inflation:  

The  inflation  occurred  after  the  war  is  called  post  war  inflation.  The  heavy  taxes  imposed  on  the  people  in  time  of  war  are  withdrawn in the post war period. As a result, the disposable income of the people increases without increase in output. Hence, price level rises.  

4.     On the Basis of Scope  

On the basis of scope, inflation can be classified as follows:  

a.      Comprehensive   inflation:

 When   the   prices   of   all   goods   and   services   increase throughout the economy, it is known as comprehensive inflation.  

b.      Sporadic  inflation:

 When  the  price  rises  only  in  some  sectors  of  the  economy, it is called sporadic inflation. It is also known as sectoral inflation because  it  affects  a  few  sectors  of  the  economy  but  not  whole  economy.  In  this  case,  the  price  of  some  goods  and  services  increases  due  to  certain  physical bottle neck which adversely affect of these goods.  

5.     On the Basis of Government Reaction 

On the basis of government reaction, inflation is classified as follows:  

a.      Open  inflation:

 If  the  government  does  not  make  any  effort  to  control  the  price  rise  and  the  market  mechanism  is  allowed  to  functions  without  any  intervention,  it  is  known  as  open  inflation.  Under  open  inflation,  scarce  resources are allocated among the competing industries. If there is shortage of any particular resources, the price of such resources rises.  

b.      Suppressed inflation:

 If the government checks the price rise through price control  and  rationing,  it  is  called  suppressed  inflation.  Once  these  measures  are   withdrawn,   the   demand   for   goods   increases   and   the   suppressed   inflation becomes open inflation.  

6.     On the Basis of Employment Level 

On the basis of employment level, inflation is classified as follows:  

a.      Partial  inflation:

 When  theprice  levelrises  with  the  increase  in  money  supply before full employment stage, it is called partial inflation. Before full-employment, output and employment increase with the increase in money supply. There is slight rise in the price level under partial inflation.  

b.      Full  inflation: 

After  full-employment  level,  as  price  level  rises  with  the  increase  in  money  supply,  it  is  called  full  inflation.  In  this  case,  output  and  employment  will  not  increase  with  the  increase  in  money  supply,  only  price level rises.  

7.     Other Types  

On the basis of types, inflation is classified as follows: 

a.      Ratchet inflation: 

Under ratchet inflation, the prices in certain sectors are not allowed  to  fall  even  if  there  is  every  reason  for  the  price  to  fall.  In  certain  sectors, the aggregate demand is excessive and in others, it is quite low. In the  excess  demand  sectors,  the  prices  will  rise  and  in  the  deficient  demandsectors,  the  prices  should  decline.  But  the  prices  are  not  allowed  to  fall  in  the deficient-demand sectors. As a result, the general price level rises. Such rise in price level is known as ratchet inflation. 

b.      Stagflation: 

The  simultaneous  existence  of  high  rates  of  inflation  and  unemployment  is  called  stagflation.  For  example,  after  World  War  II,  in  those  countries  which  pursued  stabilization  policies  with  an  objective  to  achieve  full-employment,  unemployment  remained  relatively  high  while  inflation rate increased. 

 8.     On the basis of Cause 

Inflation  is  caused  by  two  factors  due  to  the  increase  in  effective  demand  and  due  to  increase  in  cost  of  production.  

The  inflation  caused  by  the  increase  in  demand  is  known  as  demand  pull  inflation.  

On  the  other  hand,  the  inflation  caused by the increase in cost of production is known as the cost push inflation. 

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