Inflation: What It Is & How It Affect The Economic Growth Of The Country

What is Inflation

In economics, inflation is a general increase in the price of goods and services, and fall in purchasing value of money. Suppose a packet of 1 liter of milk was around Rs.47, two years back and today same packet of 1 liter milk is priced Rs.50, there is an increase of 4-5 percent. Let’s take another example, suppose 10 years back if you go to a shop to buy candy, it might be around 5-6 candies in 1 Re but today you will get 1 candy or nothing in 1 Re. So, what is Inflation?  This substantial and rapid increase in general price level, due to which there is decline in purchasing power and value of money, is called "inflation". Typically, it doesn’t occur, but when the price level decline and purchasing power increases, it is called deflation.

The most well-known indicator of inflation is Consumer Price Index (CPI), which measures the overall change in consumer prices based on a representative basket of goods and services over time.

Formula of  CPI 

India has experienced persistently high inflation in recent years. As a result, controlling inflation has become a key objective for policy makers. The two main indicators of inflation of in India are Wholesale Price Index (WPI) and Consumer Price Index (CPI). The WPI has been the main measure of inflation monitored by policy makers in India for several years, but as of now CPI is more widely consulted measure. Inflation measured by Consumer Price Index (CPI), came in at 7.01% June 2022 as comparing with 7.04% in may and 7.79% in April. The Consumer Price Index (CPI) of India is 174.3 for the month of August 2022. The inflation rate year over year is 7.0% and the inflation from July 2022 to August 2022 was 0.5%.

Types of Inflation

There are three types of inflation:

·       Demand Pull Inflation.

·       Cost Push Inflation.

·       Built In Inflation.

Demand Pull Inflation – The demand-pull inflation occurs as a result of increasing aggregate demand in the economy. It basically describes how demand for goods and services can drive up their prices. If something is in short supply, you can generally get people to pay more for it. Suppose, there’s a smart phone, which is recently launched and has exceptionally great features, and many people wanted to buy it, but the supply of that smart phone is very less, due to this its price will automatically increase, and inflation is caused by supply shortage.

Cost Push Inflation – The cost-push inflation occurs when there is increase in price due to rise in cost of production and no change in demand and supply. One of the best examples is oil, gasoline, and the organizations that controls majority of worlds oil reserves, if restrict its production due to any reason, will increase the production cost in gas and oil refinery industries and ultimately the price of oil and gasoline will increase.

Built In Inflation– As demand-pull inflation and cost-push inflation occurs, the employees may start asking for a raise and if the employer don’t keep their wages satisfactory, they could end up with the labor shortage. The built-in inflation creates a huge pressure at all levels of the production chain, not the least on wages.

Impact Of Inflation on Economic Growth of The Country

There are many different ways by which inflation impacts the economy of the country. Let’s discuss some of the major impacts:

·       Destroys the Purchasing Power – An overall increase in price over time reduces the purchasing power of consumers and this erosion of real income is the single biggest cost of inflation. To measure the purchasing power in traditional economic sense, you could compare the price of a good or service against the price index such as Consumer Price Index (CPI).

·       Effect on Creditors & Debtors – Inflation redistributes wealth from creditors to debtors, lenders suffer and borrower benefit out of inflation.

·       Effect on Lending – With the rise in inflation, lending institutions feel the pressure of higher lending. Institute don’t revise the nominal rate of interest as ‘real cost of borrowing’ falls by the same with which inflation rises.

·       Effect on Investment – Investment in the economy is boosted by the inflation as higher inflation indicates higher demand and suggests entrepreneurs to expand their production level and another reason, as inflation goes higher, the cost of loan reduces.

·       Increase in Income – Inflation affects the income of individual and firms. An increase inflation, increases the nominal value of income, while real value of income remains the same.

As we have discussed above, increase in price levels destroys the purchasing power of the money in the short-run, but in long run the income level also increases.

·       Effect on Savings – Savings are adversely affected by inflation. The level of inflation increases at the time of inflation.

·       Effect on Employment – In the initial phase of employment, there is a huge increase in employment, but as the time passes, this employment reduces drastically.

·       Effect on Producers – At the time of inflation these are biggest gainers, because demand increases, due to which production increases, price increases, profit increases and the raw material which they already have consumes at inflated rate only.

·       Effect on Resource allocation – For any economy, inflation has huge impact on resource allocation. If we are talking about resources, we all know resources are limited, due to inflation, there comes drastic change in productive setup. Let’s take an example, in an economy, cars were produced more, but after inflation, the demand in two-wheeler industry increased as two wheelers are more economic.

As “Azim Premji” says “Inflation is taking up the poverty line, and poverty is not just economic but defined by way of health and education”.