Wednesday, February 11, 2015

Inflation - Part I

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Suppose, you lived in "peace" (in context of your spending) in the year 2010, when you bought vegetables or fruits (or any other commodity) in much less price (than present). But at present i.e. in 2015, the prices of the same things have gone up which means you have to spend much more, than you used to spend in 2010. This phenomenon is known as Inflation.

And if the government thinks that the year 2010 was "ideal" year to compare the prices with, then the year can be determined as base year (fixed by government; and generally changes with trends in economy throughout periods of time)

For example, if in 2010 (suppose fixed as base year), the price of potato was Rs. 20 / kg, but the price has increased significantly throughout the period, becoming Rs. 25 / kg in 2015. Then the inflation would be simply (25 - 20) / 20 x 100 % = 25 %

Note carefully, we cannot have a clear picture of overall inflation by taking only one commodity. But then, we cannot even take all commodities (millions!) to measure inflation. Therefore, it is logical to take few (say 400 or 600, only a figure) most used and important commodities in market to measure inflation.

Also note that the price of commodities can be less than the base year. then it will be known as Deflation (opposite of Inflation).

Stages of Inflation

Depending on the intensity of inflation, we can have several stages -

  • Creeping Inflation - (slow) - 2 - 4 % inflation
  • Trotting Inflation - (moderate) - 4 - 10 % inflation
  • Galloping Inflation - (fast) - 10 - 20 % inflation
  • Hyper Inflation - (very fast) - more than 20 % inflation

Types of Inflation

Inflation can occur for several reasons, hence there are several types of inflation -
  • Demand-Pull Inflation -
    This type of inflation occurs, when the total demand for goods and services exceeds the available supply in the market (meaning more goods needed, but limited stock). As an effect, prices of those commodities increase. It is also known as Excess-Demand Inflation.
  • Pricing Power Inflation -
    This type of inflation occurs, when business houses or industries increase prices of commodities to increase their profit margin significantly. Generally, they have few or no competitors in their market segment, making their business into monopoly. It is also known as Administered Price Inflation or Oligopolistic Inflation.
  • Cost-Push Inflation -
    This type of inflation occurs, due to the increase in prices of raw materials, wage of employees, etc. making the ultimate product more costly. For example, price of car will rise, if the price of raw materials to make a car increases.
  • Sectoral Inflation -
    This type of inflation occurs in a sector, due to the rise in prices in another sector, on which the sector is dependent on. For example, ticket price of bus will increase due to the increased price of diesel.

(to be continued..)

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