Wednesday, July 18, 2012

Inflation: Meaning and its causes


Inflation is a sustained rise in the price of various commodities in an economy. Inflation is calculated by comparing the price levels of a representative sample of commodities (since , it would be too cumbersome and time consuming to take into account all commodities sold in the market) in the current year to the prices during the same period in the last year.
For example , if the price of a commodity X, which was available at Rs. 10 in the first week of 2011 , is Rs. 11 in the first week of 2012 , then the prices have risen by (Rs.11-Rs.10)=Rs.1 or (Rs. 1*100/Rs. 10)= 10%. Here , price figures which are taken into account may be either the wholesale prices (the price at which the commodities are sold by the wholesaler) or the retail prices (the price at which the commodities are sold by the retailer to the end -customers. i.e.,  prices at which we buy the various commodities) - Inflation figures so arrived at may be described as based on the Wholesale Price Index (WPI)  in the former case and Consumer Price Index (CPI) in the latter. Experts opine that CPI based inflation is nearer to ground reality as it reflects the actual impact of price rise on the general public. However, in India, inflation figures are based on WPI. Incidentally, we are migrating to the CPI based regime but this process would take around 2 or more years.

Causes of Inflation : 

High Demand

If the demand for a commodity is much above than the supply, the price of the commodity would rise. It so happened in 2010 that a slump in sugarcane production led to decreased production of refined sugar causing its prices to rise in the open market . Inflation in this case is due to high demand and hence called demand led inflation 

Supply led Inflation

The recent rise in rubber, iron and steel prices have led to an increase in the production cost of automobiles with the consequence that their prices have been hiked by the manufactures. The inflation caused by such a price rise, which was necessitated not because of an increase in demand but rather a rise in the input costs, is called supply led inflation

Black Marketing 

When a particular type of commodity has stocked by a retailer or a wholesaler and sell in the time of scarcity of the commodity then it increase the prices not only of that commodity but also those which manufactured by the stocked commodity. For example if sugar is stocked by the wholesalers this create the scarcity of the sugar in the market and when demand of sugar reach on peak then it releases on the high prices, the prices  of sweets will also go high. 

Increased Purchasing Capacity of Consumer

This kind of inflation is difficult to explain but somehow it may try. If some where a retailer increased the price of commodity for its own profit and more than 50% consumers of the city do not object of this price hike this means the 50% consumers have the capacity to purchase that commodity and this will led the inflation. 

Interest Rate on loan given to the manufacturer by the banks

When the rate of interest is increased on the corporate loan the input cost of the manufactured commodity will increased so the cost of finished goods in the market will increased.

Interest Rate on savings 

When the interest rates on the savings decreases the common man do not want to put their money into the banks and so the money will automatically flow towards the market and this will contribute to the inflation. In past few years a heavy amount of money outflows from the banks due to decreased saving interest rates. Now to control this outflow RBI is giving guidelines to the banks for more saving investment in the banks. 

International fuel prices 

The country like India is highly dependent on the import of crude oil. It imports more than 70% crude oil  from the countries like Iran , and other Arab countries. This crude oil is refined and  than converted into petroleum products like petrol, diesel, cooking gas, CNG, Kerosene oil, and many more. These fuels are running our houses as well as our transportation system. So, if the price of crude oil fluctuates in International market then in that consequence the price of all commodities will get affected.

Foreign Exchange rate 

Recently we saw the value of Rupee has depreciated to a new record value in  June 2012 which was more than Rs.57 against US Dollar. The price of a Dollar in ( Data source: Monthly Economic Report, Ministry of Finance, Govt. of India. )
  • March 2009 was Rs. 51.22
  • March 2010 was Rs. 45.49
  • March 2011 was Rs. 44.96
  • March 2012 was Rs. 50.32
  • April 2012 was   Rs. 51.81
  • May 2012 was Rs. 54.47
This fluctuation in the price of rupee against dollar contribute highly to inflation. First we are not independent of the crude oil generation so we purchase the crude oil from other countries. To make this deal we have to pay the dollar for an international deal and to purchase dollar we have pay more amount in Rupees if the price of  a dollar is high. Interest rate on loan taken from other countries and IMF will become more costly. It simply means the import becomes costly and  interest paid on the debt taken contribute to inflation.

At  the end the list of causes not limited here. Many other causes are also contributing to inflation. But we, at least understand the concept of inflation and the impact on our life, so that any means, if possible we can somehow save ourselves from the impact of Inflation.

Narender Sharma

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