INFLATION

(ASSIGNMENT # 1 FALL-2024)
Submission Date (June 12 , 2024 )
BY
MUNAIMA ZAHEER
ROLL#123456789
Pharma-103 (Inflation Description )
D-Pharma Semester 1st Section-A
Dr Jeon Jungkook
Department of Pharmacy

UNIVERSITY OF CENTRAL PUNJAB

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Table of Contents

Types of Inflation: ...................................................................................................................... 3

(a) According to Causes: ........................................................................................................ 4
(b) According to Speed or Intensity: ...................................................................................... 5
Causes of Inflation: ................................................................................................................ 6
Effects of Inflation: ................................................................................................................ 7

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 INFLATION
A sustained rise in the prices of commodities that leads to a fall in the purchasing power of a
nation is called Inflation. Although inflation is a part of the normal economic phenomena of
any country, any increase in inflation above a pre-determined level is a cause of concern. The
causes of inflation are many. While it is -often cited that a drop in India’s agricultural output
lead to the decline in supply, figures tell a different story.
Inflation and unemployment are the two most talked-about
words in the contemporary society. These two are the big
problems that plague all the economies. Almost everyone is
sure that he knows what inflation exactly is, but it remains a
source of great deal of confusion because it is difficult to
define it unambiguously.
Inflation is often defined in terms of its supposed causes. Inflation exists when money supply
exceeds available goods and services. Or inflation is attributed to budget deficit financing. A
deficit budget may be financed by additional money creation. But the situation of monetary
expansion or budget deficit may not cause price level to rise. Hence the difficulty of defining
‘inflation’.
Inflation may be defined as ‘a sustained upward trend in the general level of prices’ and not
the price of only one or two goods. G. Ackley defined inflation as ‘a persistent and
appreciable rise in the general level or average of prices’. In other words, inflation is a state
of rising price level, but not rise in the price level. It is not high prices but rising prices that
constitute inflation.
It is an increase in the overall price level. A small rise in prices or a sudden rise in prices is
not inflation since these may reflect the short term workings of the market. It is to be pointed
out here that inflation is a state of disequilibrium when there occurs a sustained rise in price
level.
It is inflation if the prices of most goods go up. However, it is difficult to detect whether there
is an upward trend in prices and whether this trend is sustained. That is why inflation is
difficult to define in an unambiguous sense.
Let’s measure inflation rate. Suppose, in December 2007, the consumer price index was
193.6 and, in December 2008 it was 223.8. Thus the inflation rate during the last one year
was 223.8 – 193.6/193.6 × 100 = 15.6%.
As inflation is a state of rising prices, deflation may be defined as a state of falling prices but
not fall in prices. Deflation is, thus, the opposite of inflation, i.e., rise in the value or
purchasing power of money. Disinflation is a slowing down of the rate of inflation.

Types of Inflation:
As the nature of inflation is not uniform in an economy for all the time, it is wise to
distinguish between different types of inflation. Such analysis is useful to study the
distributional and other effects of inflation as well as to recommend anti-inflationary policies.
Inflation may be caused by a variety of factors. Its intensity or pace may be different at

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different times. It may also be classified in accordance with the reactions of the government
toward inflation.

(a) According to Causes:

i. Currency Inflation:
This type of inflation is caused by the printing of currency notes.
ii. Credit Inflation:
Being profit-making institutions, commercial banks sanction more loans and advances to the
public than what the economy needs. Such credit expansion leads to a rise in price level.
iii. Deficit-Induced Inflation:
The budget of the government reflects a deficit when expenditure exceeds revenue. To meet
this gap, the government may ask the central bank to print additional money. Since pumping
of additional money is required to meet the budget deficit, any price rise may be called
deficit-induced inflation.
iv. Demand-Pull Inflation: An increase in aggregate demand over the available output leads
to a rise in the price level. Such inflation is called demand-pull inflation (henceforth DPI).
But why does aggregate demand rise? Classical economists attribute this rise in aggregate
demand to money supply.
If the supply of money in an economy exceeds the available goods and services, DPI appears.
It has been described by Coulborn as a situation of “too much money chasing too few goods”.
Keynesians hold a different argu-ment. They argue that there can be an autonomous increase
in aggregate de-mand or spending, such as a rise in consumption demand or investment or
government spending or a tax cut or a net increase in exports (i.e., C + I + G + X – M) with
no increase in money supply. This would prompt upward adjustment in price. Thus, DPI is
caused by both monetary factors (clas-sical argument) and non-monetary fac-tors (Keynesian
argument).
DPI can where we measure output on the horizontal axis and price level on the vertical axis.
In Range 1, total spending is too short of full
employment output, Yf. There is little or no rise in price
level. As demand now rises, output will rise. The
economy enters Range 2 where output approaches full
employment situation. Note that, in this region, price
level begins to rise. Ultimately, the economy reaches full
employment situation, i.e., Range 3, where output does
not rise but price level is pulled upward. This is demand-
pull inflation. The essence of this type of inflation is “too
much spending chasing too few goods.”T

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v. Cost-Push Inflation:
Inflation in an economy may arise from the overall increase in the cost of production. This
type of inflation is known as cost-push inflation (henceforth CPI). Cost of production may
rise due to increase in the price of raw materials, wages, etc. Often trade unions are blamed
for wage rise since wage rate is not market-determined. Higher wage means higher cost of
[Link] of commodities are thereby increased. A wage-price spiral comes into
operation. But, at the same time, firms are to be blamed also for the price rise since they
simply raise prices to expand their profit margins. Thus we have two important variants of
CPI: wage-push inflation and profit-push inflation. Anyway, CPI stems from the leftward
shift of the aggregate supply curve.

(b) According to Speed or Intensity:

i. Creeping or Mild Inflation:
If the speed of upward thrust in prices is very low then we have creeping inflation. What
speed of annual price rise is a creeping one has not been stated by the economists? To some, a
creeping or mild inflation is one when annual price rise varies between 2 p.c. and 3 p.c.
If a rate of price rise is kept at this level, it is considered to be helpful for economic
development. Others argue that if annual price rise goes slightly beyond 3 p.c. mark, still then
it is considered to be of no danger.
ii. Walking Inflation:
If the rate of annual price increase lies between 3 p.c. and 4 p.c., then we have a situation of
walking inflation. When mild inflation is allowed to fan out, walking inflation appears. These
two types of inflation may be described as ‘moderate inflation’.
Often, one-digit inflation rate is called ‘moderate inflation’ which is not only predictable, but
also keep people’s faith on the monetary system of the country’. People’s confidence get lost
once moderately maintained rate of inflation goes out of control and the economy is then
caught with the galloping inflation.
iii. Galloping and Hyperinflation:
Walking inflation may be converted into running inflation. Running inflation is dangerous. If
it is not controlled, it may ultimately be converted to galloping or hyperinflation. It is an
extreme form of inflation when an economy gets shattered. “Inflation in the double or triple
digit range of 20, 100 or 200 per cent a year is labelled galloping inflation”.
iv. Government’s Reaction to Infla-tion:
Inflationary situation may be open or suppressed. Because of ant-inflationary policies
pursued by the government, inflation may not be an embarrassing one. For instance, an
increase in income leads to an increase in consumption spending which pulls the price level
up.
If the consumption spending is countered by the government via price control and
rationingdevice, the inflationary situation may be called a suppressed one. Once the
government curbs are lifted, the suppressed inflation becomes open inflation. Open inflation
may then result in hyperinflation.

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Causes of Inflation:
Inflation is mainly caused by excess demand/or decline in aggregate supply or output.
Former leads to a rightward shift of aggregate demand curve while the latter causes aggregate
supply curve to shift leftward. Former is called demand-pull inflation (DPI) and the latter is
called cost- push inflation (CPI).
Before describing the factors that lead to a rise in aggregate demand and a decline in
aggregate supply, we like to explain “demand-pull” and “cost- push” theories of inflation.
Demand-Pull Inflation Theory:
There are two theoretical approaches to DPI —one is the classical and the other is the
Keynesian.
According to classical economists or monetarists, inflation is caused by the increase in money
supply which leads to a rightward shift in negative sloping aggregate demand curve.
Given a situation of full employment, classicists maintained that a change in money supply
brings about an equi-proportionate change in price level. That is why monetrarists argue that
inflation is always and everywhere a monetary phenomenon.
Keynesians do not find any link between money supply and price level causing an upward
shift in aggregate demand. According to Keynesians, aggregate demand may rise due to a rise
in consumer demand or investment demand or government expenditure or net exports or the
combination of these four.
Causes of Demand-Pull Inflation:
DPI originates in the monetary sector. Monetarists’ argument that “only money matters” is
based on the assumption that at or near full employment, excessive money supply will
increase aggregate demand and will thus cause inflation.
An increase in nominal money supply shifts aggregate demand curve rightward. This enables
people to hold excess cash balances. Spending of excess cash balances by them causes price
level to rise. Price level will continue to rise until aggregate demand equals aggregate supply.
Keynesians argue that inflation originates in the non-monetary sector or the real sector.
Aggregate demand may rise if there is an increase in consumption expenditure following a
tax cut. There may be an autonomous increase in business investment or government
expenditure. Governmental expenditure is inflationary if the needed money is procured by the
government by printing additional money.
In brief, an increase in aggregate demand i.e., increase in (C + I + G + X – M) causes price
level to rise. However, aggregate demand may rise following an increase in money supply
generated by the printing of additional money (classical argument) which drives prices
upward. Thus, money plays a vital role. That is why Milton Friedman believes that inflation
is always and everywhere a monetary phenomenon.

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There are other reasons that may push aggregate demand and, hence, price level upwards. For
instance, growth of population stimulates aggregate demand. Higher export earnings increase
the purchasing power of the exporting countries.
Additional purchasing power means additional aggregate demand. Purchasing power and,
hence, aggregate demand, may also go up if government repays public debt. Again, there is a
tendency on the part of the holders of black money to spend on conspicuous consumption
goods. Such tendency fuels inflationary fire. Thus, DPI is caused by a variety of factors.
Cost-Push Inflation Theory:
In addition to aggregate demand, aggregate supply also generates inflationary process. As
inflation is caused by a leftward shift of the aggregate supply, we call it CPI. CPI is usually
associated with the non-monetary factors. CPI arises due to the increase in cost of production.
Cost of production may rise due to a rise in the cost of raw materials or increase in wages.
Such increases in costs are passed on to consumers by firms by raising the prices of the
products. Rising wages lead to rising costs. Rising costs lead to rising prices. And rising
prices, again, prompt trade unions to demand higher wages. Thus, an inflationary wage-price
spiral starts.

Effects of Inflation:
People’s desires are inconsistent. When they act as buyers they want prices of goods and
services to remain stable but as sellers they expect the prices of goods and services should go
up. Such a happy outcome may arise for some individuals; “but, when this happens, others
will be getting the worst of both worlds.” Since inflation reduces purchasing power it is bad.
The old people are in the habit of recalling the days when the price of say, meat per kilogram
cost just 10 rupees. Today it is Rs. 250 per kilogram. This is true for all other commodities.
When they enjoyed a better living standard. Imagine today, how worse we are! But
meanwhile, wages and salaries of people have risen to a great height, compared to the ‘good
old days’. This goes unusually untold.
When price level goes up, there is both a gainer and a loser. To evaluate the consequence of
inflation, one must identify the nature of inflation which may be anticipated and
unanticipated. If inflation is anticipated, people can adjust with the new situation and costs of
inflation to the society will be smaller.
In reality, people cannot predict accurately future events or people often make mistakes in
predicting the course of inflation. In other words, inflation may be unanticipated when people
fail to adjust completely. This creates various problems.
One can study the effects of unanticipated inflation under two broad headings:
(i) Effect on distribution of income and wealth
(ii) Effect on economic growth.
(a) Effects of Inflation on Income and Wealth Distribution:
During inflation, usually people experience rise in incomes. But some people gain during
inflation at the expense of others. Some individuals gain because their money incomes rise

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more rapidly than the prices and some lose because prices rise more rapidly than their
incomes during inflation. Thus, it redistributes income and wealth.
Though no conclusive evidence can be cited, it can be asserted that following categories of
people are affected by inflation differently:
i. Creditors and Debtors:
Borrowers gain and lenders lose during inflation because debts are fixed in rupee terms.
When debts are repaid their real value declines by the price level increase and, hence,
creditors lose. An individual may be interested in buying a house by taking a loan of Rs. 7
lakh from an institution for 7 years.
The borrower now welcomes inflation since he will have to pay less in real terms than when
it was borrowed. Lender, in the process, loses since the rate of interest payable remains
unaltered as per agreement. Because of inflation, the borrower is given ‘dear’ rupees, but pays
back ‘cheap’ rupees.
However, if in an inflation-ridden economy creditors chronically loose, it is wise not to
advance loans or to shut down business. Never does it happen. Rather, the loan- giving
institution makes adequate safeguard against the erosion of real value.
ii. Bond and Debenture-Holders:
In an economy, there are some people who live on interest income—they suffer most.
Bondholders earn fixed interest income:
These people suffer a reduction in real income when prices rise. In other words, the value of
one’s savings decline if the interest rate falls short of inflation rate. Similarly, beneficiaries
from life insurance programmes are also hit badly by inflation since real value of savings
deteriorate.
iii. Investors:
People who put their money in shares during inflation are expected to gain since the
possibility of earning business profit brightens. Higher profit induces owners of firms to
distribute profit among investors or shareholders.
iv. Salaried People and Wage-Earners:
Anyone earning a fixed income is damaged by inflation. Sometimes,
unionized worker succeeds in raising wage rates of white-collar
workers as a compensation against price rise. But wage rate changes
with a long time lag. In other words, wage rate increases always lag
behind price increases.
Naturally, inflation results in a reduction in real purchasing power of
fixed income earners. On the other hand, people earning flexible
incomes may gain during inflation. The nominal incomes of such
people outstrip the general price rise. As a result, real incomes of this
income group increase.

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v. Profit-Earners, Speculators and Black Marketeers:
It is argued that profit-earners gain from inflation. Profit tends to rise during inflation. Seeing
inflation, businessmen raise the prices of their products. This results in a bigger profit. Profit
margin, however, may not be high when the rate of inflation climbs to a high level.
However, speculators dealing in business in essential commodities usually stand to gain by
inflation. Black marketeers are also benefited by inflation.
Thus, there occurs a redistribution of income and wealth. It is said that rich becomes richer
and poor becomes poorer during inflation. However, no such hard and fast generalizations
can be made. It is clear that someone wins and someone loses from inflation.
These effects of inflation may persist if inflation is unanticipated. However, the redistributive
burdens of inflation on income and wealth are most likely to be minimal if inflation is
anticipated by the people.
With anticipated inflation, people can build up their strategies to cope with inflation. If the
annual rate of inflation in an economy is anticipated correctly people will try to protect them
against losses resulting from inflation.
Workers will demand 10 p.c. wage increase if inflation is expected to rise by 10 p.c.
Similarly, a percentage of inflation premium will be demanded by creditors from debtors.
Business firms will also fix prices of their products in accordance with the anticipated price
rise. Now if the entire society “learns to live with inflation”, the redistributive effect of
inflation will be minimal.
However, it is difficult to anticipate properly every episode of inflation. Further, even if it is
anticipated it cannot be perfect. In addition, adjustment with the new expected inflationary
conditions may not be possible for all categories of people. Thus, adverse redistributive
effects are likely to occur.
Finally, anticipated inflation may also be costly to the society. If people’s expectation
regarding future price rise become stronger they will hold less liquid money. Mere holding of
cash balances during inflation is unwise since its real value declines. That is why people use
their money balances in buying real estate, gold, jewellery, etc.
Such investment is referred to as unproductive investment. Thus, during inflation of
anticipated variety, there occurs a diversion of resources from priority to non-priority or
unproductive sectors.
b. Effect on Production and Economic Growth:
Inflation may or may not result in higher output. Below the full employment stage, inflation
has a favourable effect on production. In general, profit is a rising function of the price level.
An inflationary situation gives an incentive to businessmen to raise prices of their products so
as to earn higher doses of profit.

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Rising price and rising profit encourage firms to make larger investments. As a result, the
multiplier effect of investment will come into operation resulting in higher national output.
However, such a favourable effect of inflation will be temporary if wages and production
costs rise very rapidly.
Further, inflationary situation may be associated with the fall in output, particularly if
inflation is of the cost-push variety. Thus, there is no strict relationship between prices and
output. An increase in aggregate demand will increase both prices and output, but a supply
shock will raise prices and lower output.
Inflation may also lower down further production levels. It is commonly assumed that if
inflationary tendencies nurtured by experienced inflation persist in future, people will now
save less and consume more. Rising saving propensities will result in lower further outputs.
One may also argue that inflation creates an air of uncertainty in the minds of business
community, particularly when the rate of inflation fluctuates. In the midst of rising
inflationary trend, firms cannot accurately estimate their costs and revenues. Under the
circumstance, business firms may be deterred in investing. This will adversely affect the
growth performance of the economy.
However, slight dose of inflation is necessary for economic growth. Mild inflation has an
encouraging effect on national output. But it is difficult to make the price rise of a creeping
variety. High rate of inflation acts as a disincentive to long run economic growth. The way
the hyperinflation affects economic growth is summed up here.
We know that hyperinflation discourages savings. A fall in savings means a lower rate of
capital formation. A low rate of capital formation hinders economic growth. Further, during
excessive price rise, there occurs an increase in unproductive investment in real estate, gold,
jewellery, etc.
Above all, speculative businesses flourish during inflation resulting in artificial scarcities and,
hence, further rise in prices. Again, following hyperinflation, export earnings decline
resulting in a wide imbalance in the balance of payments account.
Often, galloping inflation results in a ‘flight’ of capital to
foreign countries since people lose confidence and faith over
the monetary arrangements of the country, thereby resulting in
a scarcity of resources. Finally, real value of tax revenue also
declines under the impact of hyperinflation. Government then
experiences a shortfall in investible resources.
Thus, economists and policy makers are unanimous regarding
the dangers of high price rise. But the consequence of
hyperinflation is disastrous. In the past, some of the world
economies (e.g., Germany after the First World War (1914-
1918), Latin American countries in the 1980s) had been greatly
ravaged by hyperinflation.
The German Inflation of 1920s was also Catastrophic:

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During 1922, the German price level went up 5,470 per cent, in 1923, the situation worsened;
the German price level rose 1,300,000,000 times. By October of 1923, the postage of the
lightest letter sent from Germany to the United States was 200,000 marks.
Butter cost 1.5 million marks per pound, meat 2 million marks, a loaf of bread 200,000
marks, and an egg 60,000 marks Prices increased so rapidly that waiters changed the prices
on the menu several times during the course of a lunch!! Sometimes, customers had to pay
double the price listed on the menu when they observed it first!!!
During October 2008, Zimbabwe, under the President-ship of Robert G. Mugabe,
experienced 231,000,000 p.c. (2.31 million p.c.) as against 1.2 million p.c. price rise in
September 2008—a record after 1923. It is an unbelievable rate. In May 2008, the cost of
price of a toilet paper itself and not the costs of the roll of the toilet paper came to 417
Zimbabwean dollars.
Anyway, people are harassed ultimately by the high rate of inflation. That is why it is said
that ‘inflation is our public enemy number one’. Rising inflation rate is a sign of failure on
the part of the government.

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