Basic definitions and concepts of Inflation

By   @shriyansh,   2 years ago

This article is a part of series from Economics. In this article we will be talking about basic definitions and concepts used in Inflation. We will also talk about how it works and its effects on the economics of the nation.

What is inflation?

This is the rate of increase in general level prices of goods and services over a period of time. (So simple).

For example if cost of onions or college fees increases, its inflation. We will talk about why and how it happens and how it effects us in later sections.

Other related concepts to inflation are

  • Deflation : This is rate of decrease in price of goods and services. Yes, this is just opposite of inflation.
  • Disinflation : This is slowdown in the rate of increase in the rate of inflation. For example if inflation was 7% earlier and it came down to 4%. Here inflation is still positive but its rate is decreasing. This is different from deflation.

What are the Causes of Inflation

For understanding this you need to understand the demand and supply relation.

Example : Assume if there are only 10 potatoes today in market and 10 people are there to buy it and every one buys one potato at ₹10/potato. Here the supply is 10 and demand is also 10.

Now if tomorrow, we have 10 potatoes but if 50 people are there to buy them in the market. In this case what should happen? People who really want to buy it will offer a higher price suppose ₹15/potato, and they will win because sellers will sell them because they are getting higher price. So the concept here is:

  • Concept 1: If demand of a entity increases and its supply is limited, its price will increase
  • Concept 2: If demand of an entity decreases and its supply remains same, its price will decrease.

Now types of causes :

  • Demand pull inflation : If money in people's pocket increases somehow (salary time, people get more jobs) and due to this demand increases with supply remaining the same. This causes inflation as per concept 1.
  • Cost push inflation : If somehow supply of products in the market decreases (Bad monsoon, Hoarding), and demand remains same. Sellers will sell at higher cost, causing inflation.

Types of inflation

  • Hyperinflation : Very high and accelerating rate of inflation. This erodes the currency of a nation and people start loosing their faith in their currency
  • Galloping Inflation : When the inflation is increasing by double or triple digit per annum.
  • Stagflation : It is high inflation along with recession (Low economic growth and high unemployment).

How is inflation measured?

Inflation is measure through various standard price indices. The major ones that has larger base are CPI (Consumer Price Index) and WPI (Wholesale price index). While CPI deals with the prices that consumer pays for his daily needs, WPI deals with the prices in which the wholesale market plays. The current prices are compared to the price level in certain past year called Base year, to get the inflation.

Consumer Price Index (CPI) : It is the weighted average of price of commodities (goods and services) used by consumers. The commodities used under this index are fixed and called Consumption basket. The weight given to each commodity if defined in proportion to its importance and frequency of use by consumers. CPI is calculated every month and is different for different regions.

List of commodities in order or their weight : Food > Fuel > Beverages > Clothes > Electronics > Vehicles

There are three varieties of CPI based on type of consumers :

  • CPI-AL : CPI for agricultural labourers
  • CPI-IW : CPI for Industrial workers
  • CPI-UNME : CPI for Urban non-manual labourers

Wholesale Price Index (WPI) : It is the weighted average of commodities dealt in the wholesale market. Services are not included in this as services are served directly to consumers. WPI is calculated every week for the whole nation. As the prices of products are less in Wholesale market as compared to price paid by consumers, WPI is less than CPI and contains more goods than CPI's consumption basket.

Other Indices :

Producer's Price Index (PPI): It deals with prices for producers. Its like CPI for producers.

NHB RESIDEX : It is prices in housing industry and is calculated by Nation Housing Bank (NHB).


Other Concepts Related to inflation :

  • Base Effect : When we calculate the percentage of increase in general price levels for the current year in comparison to the previous year. For the same amount of increase in price we get different percentage increase due to the base price. Example. If price of sugar is 100/kg in 2016, it increases by ₹20 in 2017 and again by ₹20 in 2018. But if we calculate it as percentage increase we get
  • For 2016-2017 ₹ (20/100)*100 = 20% inflation
  • For 2017-2018 ₹ (20/120)*100 = 16.7% inflation
  • Here although the amount of increase is same (₹20) for 2016-2017 and 2017-2018 but in percentage its decreasing for 2016-2017 20% but for 2017-2018 its 16.6% (due to increased denominator). It appears from percentage values that inflation is decreasing but actually it is same (₹20). This is called the base effect.

  • Phillips Curve : It tells that there is an inverse relation between inflation and unemployment. If inflation is more unemployment will be more and vice-versa.

Author : Shriyansh Gautam
Shriyansh Gautam

Civil Services Aspirant

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