When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation also reflects erosion in the purchasing power of money - a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index over time.
Essentially what this means is that the value of your money is going down and it takes more money to buy things. Therefore a 4% inflation rate means that the price level for that given year has risen 4% from a certain measuring year. The inflation rate is determined by finding the difference between price levels for the current year and previous given year. The answer is then divided by the given year and then multiplied by 100. To measure the price level, economists select a variety of goods and construct a price index such as the consumer price index (CPI). By using the CPI, which measures the price changes, the inflation rate can be calculated. This is done by dividing the CPI by the beginning price level and then multiplying the result by 100.
Causes of Inflation
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The different causes of inflation that affects that has been seen in the Indian economy since times would be:-
Demand Pull Inflation: This is basically when the aggregate demand exceeds the aggregate supply. It states that when there is a huge demand of a product it is natural that companies increase the price of it as the supply is not as per the demand. For example: Real estate (in India).
Cost-Push Inflation: This is caused when there is supply shock i.e. price rises even though there is no increase in the aggregate demand. This is because of the non availability of the commodity. This may happen if the cost of especially the wage cost rises.
Imported Inflation: This inflation is due to the increase in the price of imports. Increase in price of imports is in direct relation with the expenditure-based measure of inflation.
Other: When the country prints excess currency notes the price increases in order to keep up with the increase in currency that leads to inflation.
: Increase in indirect taxes leads to increase in price of the commodities.
: When countries borrow money, they need to cope up with the interest burden. This interest burden leads to inflation.
: Increase in the production and labour cost have a direct impact on the final product, resulting in inflation.
Effects of Inflation
Inflation's effects on an economy are various and can be simultaneously positive and negative. The effects of inflation on various parts of society are:
Business Community: Inflation is welcomed by entrepreneurs and businessmen because the stand to profit by rising prices. The value of inventories and stock prices eventually rises and even the price of the commodity rises faster than the cost of production which in turn increases the profit of the business.
Common people: Inflation has a great effect on the people with limited income i.e. of the wage earners and salaried people who in easy language called common people or aam aadmi.
Farmers: Farmers usually gain during inflation, as the et better prices for their harved goods during inflation.
Investors: Investors investing in bonds, debentures, etc suffer a loss during inflation. Whereas investors in equity gain during inflation as more dividend is yield on high profit made by the joint sector companies.
Inflation will lead to deterioration of gross domestic savings and less capital formation in the economy and less long term economic growth rate of the economy.
Trends of Inflation in INDIA
India has been plagued by the disease of inflation since 1950's, but it had started showing its harmful symptoms and ill effects since 1991. Kick started by the financial crises of 1991, marked by deficits in government finances and devaluation of rupee, a whooping inflation of 13.9% took its toll on the Indian economy. Though later controlled, average inflation had been recorded as 9.3% per year till the end of 19th century.
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In the beginning of 20th century the inflation had been controlled to a great extent but it again roused by some level from 2006 onwards.
Last year i.e. 2011, the inflation rate was recorded as 8.9%.
The fluctuations in the inflation rate from the year 1991 to 2011 are:
Analysis of the inflation rate:
From the graph above it can stated that in the 19th century the inflation rate was at high level where at in the beginning of 20th century the rate eventually falls down.
In the year 2000(considered as the base year for the calculations as there were less fluctuations in the economy regarding natural disaster, government policies, etc.) the inflation rate is the lowest, nearly around 0.
As we perform statistical operation on the inflation trend we can see average Indian inflation rate to be 8% from 1969 to 2012. In this range of time the maximum inflation recorded (34.7%) in September 1974 and minimum (-11.3%) in May 1976.
To understand the fluctuations of the inflation rates let us divide it into 2segments:
Reasons for inflation during 90's.
Reasons for inflation in the 21st century.
Reasons for inflation during 90's.
The main reason for inflation in 1990 was the rise in oil prices which almost doubled the prices.
Flawed policies of the government during the preceding years.
The mini oil shock following the outbreak of Gulf War.
Continuous increase in the price of food products.
Low industrial growth sector.
Imports exceeds the exports, rose to about 15600 cores, as a result India had to borrow money from IMF(International Monetary Fund)
Reasons for inflation in 21st century
By the end of 20th century i.e. in the year 1999 the inflation rate broke down to 4.7% from 13.2% in the year 1998, which was very good for the economy. So due to this the start of 21st century was a good with the low inflation rate in the decade of 10years i.e. 4%.
In the fiscal year 2002-2003, India witnessed inflation due to:
Increase in oil prices
Increase in prices of agriculture products like oilseeds, edible oils.
Increase in government expenditure.
Inflation from the year 2006 again rose up and crossed 6% bar.
In the year 2008-2009 the inflation was up and crossed 8% bar. In 2008 and 2009 the inflation rate was 8.4 and 10.9 per cent respectively. Reasons for rise inflation in the year 2008-2009:
Crude oil prices
Reducing the rate of interest by the government.
New printing of money
Increase in prices of food products.
In 2009-10, the rise in inflation was due to certain factors like shortage of supply of food products like cereals, pulses, wheat, and rice.
In 2010-11, inflation occurred due to increase in demand of fruits and vegetables as a result of increase in its price and also due to the increase in price commodity products like crude oil.
The inflation in India from 1991 till date was mostly due to the rise in crude oil prices and food prices which made a tremendous change in the general price level.
With the introduction of reform like Globalization in India, the economy has been affected to a large extent because of changes happening in the outside world in both sense good as well as bad.