Inflation - Types, Roles & Effect on Economy

Inflation - Types, Roles, Effect on Economy

What is Inflation?

Inflation can be defined as a sustained increase in the general level of prices for goods and services. It is measured as an increase in annual percentage. That means in simpler terms we can say that as inflation rises every rupee buys a smaller percentage of goods or services.

During inflation the value of a rupee keeps fluctuating. The value of a rupee is observed based on the purchasing power that means the real tangible goods that money can buy. During a rise in inflation, the purchasing power of money goes down. After inflation, the same amount of money can buy less than it could do before.

Types of Inflation

• Demand Pull Inflation: This type of inflation is also known as wage pull inflation where the demand is more than the supply. In such cases when wage inflation occurs the prices for the products and services increases thus leading to Demand Pull Inflation. Hence, the name DPI. For example, this could happen during a war due to high level of changes in the economy.
• Cost Push Inflation: When an increase of price occurs in regard to the product or maintenance of a service or product then the resultant effect is the increased price value. With higher wage the cost of production also increases which means that the commodity price also increases sharply. For example, if a car manufacturer pays greater price for a part of the car then the labor price will be decreased to balance the cost.
• Pricing Power Inflation: This is also known as ‘Administered Price Inflation’ where the business and individuals increase their prices just for profit. As a result it leads to market instability. However, this doesn’t happen during economic depression or instability and is in no way related to such times.
• Deficit Based Inflation: At times when the expenditure exceeds the revenue the government may ask the central bank to print money to meet the gap. If there is any rise in price at such times it can lead to inflation based on deficit.
• Sectoral Inflation: When the price of one product affects the price of another product or service it can lead to inflation. This kind of inflation occurs generally across the retail industry causing changes in prices when the production cost increases.

Stages of Inflation

Based on the characteristics and intensity of inflation there are several stages to the types of inflation such as:

• Creeping Inflation: This is that stage of inflation when the rise in price level is slow and steady over a period of time. Many economists consider mild or creeping inflation to be very important for a good growth in economy. For example the annual rise in the prices can be considered to be a part of creeping inflation.
• Walking Inflation: Also known as trotting inflation this is that stage when the annual price rises to around 5 to 10 percent. This is the stage to take precautions by the government to prevent any further inflation in the market. Once it crosses the 10 percent mark and moves to double figures that would be alarming.
• Galloping Inflation: When the rate of inflation is increasing at a sharp rate and a high speed at around 10 to 20 percent it can be considered as a galloping inflation. This stage is quite dangerous and must be controlled immediately by proper measures.
• Hyperinflation: This generally happens when the annual rise is above the 20 percent mark. This is that stage when it is not possible to control it anymore and can lead to the economy getting shattered.

What are the causes of Inflation?

• Demand pull inflation occurs when the demands of consumers, government or businesses increases than the supply. As a result the item prices increase unless supply is perfectly elastic. However, supply is slightly inelastic at all times because our market isn’t totally perfect. But the supply of goods and services can be increased with the increase in production factors.
• Cost push inflation occurs due to an increase in the production costs that is generally caused by increase in wages or an increase in profit margins. When wages are increased the business owner is compelled to increase the goods and services price that is passed on to the customers and again the same consumers are also the employees. As a result it becomes difficult to meet the sufficient standards of living as the cost of living rises. 

What are the Effects of Inflation?

• Inflation cannot always be considered to be bad. Actually it varies from person to person. When price level goes down or up there can be both a gainer or looser in such cases. But to know the result of inflation it is important to know whether it is anticipated or unanticipated. 
• If the inflation is anticipated then it is considerably easy to cope up with the increase and changes in the cost because in that case the price will be much smaller.
• However, if the inflation is unanticipated then the following problems can arise:

1. It can result in the creditors loosing while the debtors gaining if the anticipation is not correct. To borrowers it would be quite similar to getting an interest free loan. 
2. Having risks and uncertainty in the market causes organizations to work cautiously and spend less which in turn affects the long run of economic output. 
3. People who are leading a life after retirement face troubles as the purchasing power of their money decreases resulting in a decrease of the economic output in the long run. 
4. People who invest in shared and bonds are supposed to gain high profit. 
5. For those with fixed salary incomes the wage doesn’t increase with respect to the price as a result of which the real purchasing power reduces.

You May Also Like to Read: Banking Notes: Inflation (Formula of Calculating Inflation)