Q.1 Define Inflation?

Ans. Inflation is a condition, when cost of services coupled with goods rise and the entire economy
seems to go haywire. Inflation has never done good to the economy. Inflation and economic growth are parallel lines and can never meet. Inflation reduces the value of money and makes it difficult for the common people.

Causes of Inflation 1. Demand Pull Inflation

If the economy is at or close to full employment then an increase in AD leads to an increase in the price level. As firms reach full capacity, they respond by putting up prices leading to inflation

AD can increase due to an increase in any of its components C+I+G+X-M The link between output and inflation suggests that there will be a similar link between inflation and unemployment, The Phillips curve initially showed a link between money wages and unemployment, it was then argued an increase in wages would lead to inflation

2. Cost Push Inflation

If there is an increase in the costs of firms, then firms will pass this on to consumers. There will be a shift to

the left in the AS. Cost push inflation can be caused by many factors 1. The Labor Market If trades unions can present a common front then they can bargain for higher wages, this will lead to wage inflation. 2. Import prices One third of all goods are imported in the UK. If there is a devaluation then import prices will become more expensive leading to an increase in inflation E.G. a German car costs DM 40,000. If the exchange rate is DM 1:3DM then it will be priced at 13,333. If the E.R falls to 1 : 2DM then it will be priced at 20,000 3. Raw Material Prices, The best example is the price of oil, if the oil price increase by 20% then this will have a significant impact on most goods in the economy and this will lead to cost push inflation. E.g. in early 2008, there was a spike in the price of oil to over $150 causing a rise in inflation 4. Profit Push Inflation When firms push up prices to get higher rates of inflation. 5. Declining productivity

If firms become less productive and allow costs to rise, this invariably leads to higher prices.

Effects of Inflation
Investment: If the price of goods increases and people have to compensate for the increase in price, they usually make use of their savings. In the event when savings are depleted, fund for investment is no longer available. An individual tends to invest, only if savings of an individual is strong and has sufficient money to meet his daily needs.

II) Interest rates: Whenever inflation reigns supreme, it is a well known fact that the value of money goes down. This leads to decline in the purchasing power. In the event, when the rate of inflation is high, the interest rates also rise. With increase in both parameters, cost of goods will not remain the same and consequently people will have to shell out more money for the same goods.

III) Exchange rates: Inflation and economic growth are affected by exchange rates as well. Exchange rates denote the value of money prevailing in different countries. High rate of inflation causes severe fluctuations in exchange rates. This adversely affects trade (export and import), important business transaction across borders, value of money also changes.

IV) Unemployment: Growth of a nation depends to a large extent on employment. If rate of inflation is high, unemployment rate is low and vice versa. This theory is propounded by economist William Philips and this gave rise to the Philips Curve.

V) Stocks: The returns a company offer, on investment fully depend on the performance of the company. Past performance, current position of the company and future trends decide how much(money, in form of bonus or dividend) is to be returned to the investors. Owing to inflation, several monetary as well as fiscal policies are impacted. Measures to control inflation:

: 1. Monetary measures- Classical economists are of the view that inflation can be checked by controlling the supply of money. Some of the important monetary measures to check the inflation are as under: Control over money- It is suggested that to check inflation government should put strict restrictions on the issue of money by the central bank. Credit control- Central bank should pursue credit control policy .In order to control the credit it should increase the bank rate, raise minimum cash reserve ratio etc. It can also issue notice to other banks in order to control credit Fiscal measures- Measures taken by the government to control inflation. A: Decrease in public expenditure- One of the main reasons of inflation is excess public expenditure like building of roads bridges etc. Government should drastically scale down its non-essential expenditure . B-Delay in payment of old debts: Payment of old debts that fall due should be postponed for some time so that people may not acquire extra purchasing power. C-Increase in taxes : Government should levy some new direct taxes and raise rates of old taxes. D-Over valuation of money : To control the over valuation of money it is essential to encourage imports and discourage exports

Other measures 1 Increase in the production- One of the major causes of the inflation is the excess of demand over supply ,so those goods should be produced more whose prices are likely to rise rapidly .In order to increase production public sector should be expanded and private sector should be given more incentives. 2 Proper commercial policy- Those goods which are in scarcity should be imported as much as possible from other countries and their export should be discouraged. 3 Encouragement to savings During inflation government should come out with attractive saving schemes. It may issue 5 or 10 year bonds in order to attract savings. 3 Proper investment policy- Investment in those industries should be increased wherein more production of goods can be generated over a short period of time .Less investment should be made in industries having long production period. 4 Marginal requirements- It is the difference between the value of security and loan advanced.

Food Price Inflation

Food price inflation has become a major problem in India over the past few years. Price stability is crucial for sustainable growth, as persistent inflation implies higher demand relative to supply. Thus, there is an urgent need to understand this problem and to respond with appropriate agricultural policies to keep food prices stable if we are to reduce hunger and poverty in India. One reason for the rising food prices could be increasing demand for food, as income levels increase with rapid economic growth. Another reason could be supply and distribution problems. Another factor could be the increasing diversion of cereals such as corn to production of bio-fuels, especially in USA, that eventually also reflect in other countries through international food markets. However, imports of food, especially cereals, are relatively small in Indias case, so food inflation is likely to be driven mainly by domestic factors

What is causing food inflation in India?

The root cause of the food inflation in India is the demand-supply mismatch.

This mismatch is triggered by a variety of factors: 1. Natural causes: Natural causes include supply and distribution side constraints and risks due to natural calamities such as unseasonal rains, floods, droughts, pests and diseases leading to devastating effect on crop and livestock. All these natural problems result in deficiency in supply. (It is to be noted that the demand is always increasing due to rising population and a significant shift in the consumption pattern of the expanding middle class) 2. High input costs: India is a significant importer of phosphatic and complex fertilizers and large subsidies provided to them would be unsustainable in the long run and hence inflation occurs. Another reason for rising input costs is the surge in the fuel prices which is a key input for transporting agricultural commodities to processing or consumption centres.

3. Hoarding and black marketing: Hoarding refers to the practice of creating artificial shortage in the markets in order to gain higher profits. Illegal trading activities like hoarding and black marketing by intermediaries in the distribution systems are a major cause of food inflation. 4. Absence of cold storage facilities: Cold storage facilities are required to store the yield in a hygienic and safe environment. India has inefficient storage facilities. Punjab and Haryana which account for 60% of Indias grain production saw tonnes of wheat rotting because of absence of granaries. The government did nothing to save the production. 5. Low Productivity: Because of the reluctance of farmers to use scientific techniques of farming, production still remains low. Rising population also implies rise in demands and when demand is not met with a Proportionate increase in supply inflation occurs.

How Food price inflation can be dealt

State Intervention: The first step is to strengthen the state intervention both in food production and distribution. Food Security Act: Food security act must be passed as soon as possible to ensure global food security. The Government is currently holding stocks of nearly 50 million tonnes of rice and wheat, which is way above the buffer norms. 35 kgs of food grains per month should be supplied through a universalized PDS at Rs.2 per kg and not limited to the arbitrarily determined BPL families. Moreover, other essential commodities like sugar, pulses and edible oils should be supplied at fixed rates across the country through the PDS. Pooling investment resources: The farmers commissions suggestions to make farming remunerative for the peasantry and stepping up investment in agriculture as well as agricultural storage and marketing should be acted upon immediately. Curbing corporate traders: The influence of private corporates and traders in the food economy needs to be curbed. For this it is essential for the Central Government to take the State Governments on board and coordinate measures against hoarding and black-marketing. Control on fuel prices: Finally, the costs of agricultural inputs like fuel and fertilisers have to be controlled by the Government .The Government must continue to subsidise fuel and fertiliser and rationalize the taxes on petroleum products.