ASSIGNMENT VII – MANAGERIAL ECONOMICS
RIYA SINGH
19FLICCDDN01106
BBA.LLB (HONS) 1ST YEAR SEC B
Q1.HOW IS INFLATION DEFINED? CAN ANY RISE IN PRICES BE
CONSIDERED AS INFLATION? WHAT IS THE ACCEPTABLE OR
DESIRABLE LIMIT OF INFLATION?
Inflation is a quantitative measure of the rate at which the average price level of a basket of
selected goods and services in an economy increases over some period of time. It is the rise in
the general level of prices where a unit of currency effectively buys less than it did in prior
periods. Often expressed as a percentage, inflation thus indicates a decrease in the purchasing
power of a nation’s currency. Inflation can be contrasted with deflation, which occurs when
prices instead decline. As prices rise, a single unit of currency loses value as it buys fewer
goods and services. This loss of purchasing power impacts the general cost of living for the
common public which ultimately leads to a deceleration in economic growth. The consensus
view among economists is that sustained inflation occurs when a nation's money supply
growth outpaces economic growth. To combat this, a country's appropriate monetary
authority, like the central bank, then takes the necessary measures to keep inflation within
permissible limits and keep the economy running smoothly. Inflation is measured in a variety
of ways depending upon the types of goods and services considered and are the opposite of
deflation which indicates a general decline occurring in prices for goods and services when
the inflation rate falls below 0%. Inflation is the rate of increase in prices over a given period
of time. Inflation is typically a broad measure, such as the overall increase in prices or the
increase in the cost of living in a country. But it can also be more narrowly calculated—for
example, for certain goods, such as food, or for services, such as school tuition. Whatever the
context, inflation represents how much more expensive the relevant set of goods and/or
services has become over a certain period, most commonly a year. Inflation levels of 1% to
2% per year are generally considered acceptable (even desirable in some ways), while
inflation rates greater than 3% represents a dangerous zone that could cause the currency to
become devalued.
Q2.IN WHAT WAYS DOES INFLATION CONTRIBUTE TO ECONOMIC
GROWTH? WHAT KIND OF INFLATION AFFECTS ECONOMIC
GROWTH ADVERSELY?
When prices rise for energy, food, commodities, and other goods and services, the entire
economy is affected. Rising prices, known as inflation, impact the cost of living, the cost of
doing business, borrowing money, mortgages, corporate and government bond yields, and
every other facet of the economy.
Inflation can be both beneficial to economic recovery and, in some cases, negative. If
inflation becomes too high the economy can suffer; conversely, if inflation is controlled and
at reasonable levels, the economy may prosper. With controlled, lower inflation, employment
increases. Consumers have more money to buy goods and services, and the economy benefits
and grow. However, the impact of inflation on economic recovery cannot be assessed with
complete accuracy. Some background details will explain why the economic results of
inflation will differ as the inflation rate varies.
1. GDP
Economic growth is measured in gross domestic product (GDP), or the total value of all
goods and services produced. The percentage of growth or decline, compared to the previous
year, is adjusted for inflation. Therefore, if growth was 5% and inflation was 2%, GDP would
be reported at 3%. As prices rise, the value of the dollar declines, as its purchasing power
erodes with each increase in the price of basic goods and services.
2. The Cost of Borrowing
Low or no inflation, theoretically, may help an economy recover from a recession or a
depression. With both inflation and interest rates low, the cost of borrowing money for
investments or borrowing for the purchase of big-ticket items, such as automobiles or
securing a mortgage on a house or condo, is also low. These low rates are expected to
encourage consumption, say some economists. Banks and other lending institutions, however,
may be reluctant to lend money to consumers when rates of return on loans are low, which
decreases profit margins. Businesses can plan their borrowing, hiring, marketing,
improvement and expansion strategies accordingly. Investors, likewise, know roughly what
government and corporate bonds and other debt will return since most of these instruments
are pegged to Treasury yields. However, economists differ notoriously in their opinions.
Some economists claim that a 6% inflation rate for several years would help the economy by
helping to resolve the U.S. debt problem, lifting wages and stimulating economic growth.
3. The Consumer Price Index
The standard measurement of inflation is the government's Consumer Price Index (CPI).
Components of the CPI include a "basket" of certain elementary goods and services, such as
food, energy, clothing, housing, medical care, education, and communication and recreation.
If the average price of all goods and services in the CPI were to go up 3% over the previous
year's level, for example, then inflation would be pegged at 3%. This also means that the
purchasing power of the dollar would have declined by 3%.Hard assets, such as a home or
real estate, often increase in value as the CPI rises; however, fixed income instruments lose
value because their yields don't increase with inflation. Treasury inflation-protected securities
(TIPS) are a notable exception, however. Interest on these securities is paid twice yearly at a
fixed rate as the principal increases in step with the CPI, thus protecting the investment
against inflation.
