INFLATION

Concept of inflation:
Definition:
Inflation is an increase in the general price level of goods and services in an economy over a
period. Inflation occurs when the general level of prices and costs are rising.

Types of inflation:
1. Demand-pull inflation:
Demand-pull inflation arises in an economy when the demand for goods and services is
increased, however, the supply of goods and services decreases and the general price level rises.
It involves an increase in money supply, an increase in disposable income, or an increase in
aggregate demand for goods and services.

2. Cost-push inflation:
When there is an increase in the cost of factors of production, the overall cost of manufacture
increases, which leads to an increase in the prices of goods such inflation is called cost-push
inflation.
e.g. an increase in wages, or an increase in the cost of raw materials.

Reasons/causes of inflation:
• Increase in demand for goods and services
• Increase in cost of a factor of production
• Increase in cost of import
• Increase in supply of money
• Increase in public spending
• expectations of inflation that cause higher wages leading to higher costs

Theories of inflation:
1. demand-pull theory:
Demand-pull inflation is when there is an increase in aggregate demand, and the supply
remains the same or decreases. When supply cannot meet growing demand, prices for goods
and services are pulled higher.

2. cost-push theory:
Cost-push inflation is the decrease in the aggregate supply of goods and services stopping an
increase in the cost of production.

3. structural theory/situational theory:

when supply is rigid in developing countries due to structural rigidity. For example: outdated
technology, storage problems, distribution waste, infrastructure bottlenecks, lack of power, and
hoarding.
It is also defined as, when the aggregate demand rises then it is quite difficult to increase the
aggregate supply, and hence, the general level of price increases.

Deflation:
Deflation refers to a persistent decrease in the general price level of goods and services for a
significant period. It is the opposite of inflation.
Causes of Deflation:
The level of investments decreases which negatively affects the economy as the demand for
goods falls. A decrease in the people's income also causes deflation in the economy. Due to a
reduction in the income level, the demand for goods and services decreases which leads to a
decrease in price level.
To control deflation there should be a decrease in taxes, an increase in investments, a decrease
in interest rate, or an increase in consumption by offering higher discounts.

Effects of inflation and deflation:

INFLATION DEFLATION
• Invest in long-term investments.
• Reduction in Business Revenues:
When it comes to long-term investments,
In an economy faced with deflation,
spending money now for investments can
businesses must drastically reduce the prices
allow you to benefit from inflation in the
of their products or services to stay
future.
profitable. As reductions in prices take place,
• Save More:
revenues begin to drop.
Retirement requires more money than one
might imagine. The two ways to meet
• Lowered Wages:
retirement goals are to save more or invest
aggressively.
When revenues begin to drop, businesses
• Make balanced investments:
need to find means to reduce their expenses
to meet objectives. One way is by reducing
 Though investing in bonds alone feels safer, wages and cutting jobs. This adversely
invest in multiple portfolios. Do not put all affects the economy as consumers would
your eggs in one basket to outpace inflation. now have less to spend.

Hyperinflation:
When inflation increases above 50 % drastic increase in prices is termed hyperinflation.

Disinflation:
When there is a decrease in the rate of inflation such a situation is called disinflation. It is
caused by a slowdown in the rate of increase of a country’s money supply.

Difference between deflation and disinflation:

Stagflation:
It is an increase in prices with an increase in unemployment and a decrease in economic growth.
Stagflation involves an inflationary rise in prices and wages at the same time. The people are
unable to find jobs and firms are unable to find customers for what their plants can produce.
Causes of Stagflation:
The cost of resources is increased due to a lesser supply, and there is a Shortage of labor due
to changes in technology and a rise in taxes, especially indirect taxes.
To control stagflation there should be encouraged development programs especially
infrastructure-related, Encouraged training programs for the labor force, and reduced taxes on
goods and services.

Reflation:
Relation refers to an economic policy whereby a government uses fiscal and monetary stimulus
to expand a country's output. This is possibly achieved by the method that includes, reducing
the tax, changing the money supply or even adjusting the interest rates.

Difference between inflationary and deflationary gap:

Inflationary gap Deflationary gap

The excess of aggregate demand above the The lack of aggregate demand below the
level that is required to maintain a level that is required to maintain a
full employment level of equilibrium full employment level of equilibrium
is termed an inflationary gap. is termed a deflationary gap.

Inflationary gap causes inflation and The deflationary gap causes deflation and
increases wages and price levels in decreases wages and price levels in
the economy. the economy.

MONEY

Origin and growth of money:

The history of money can be dated back to as early as the start of civilization. The first and
earliest form of money was commodity money which is the exchange of goods for goods,
which was called the barter system. it was universally accepted as a medium of exchange. Then
comes the metallic money after the commodity money which involves the exchange of metals
gold, silver, copper, etc, which was later followed by coinage. The growth of money accelerated
with the advent of paper currency. In the modern era, money has evolved into digital forms,
such as cryptocurrencies and bank deposits, significantly enhancing its accessibility and
efficiency in facilitating transactions and economic growth.

Barter system:
Definition:
A system of direct exchange of one commodity or service for another without the use of money
is called barter. One has to exchange the product that one has in excess with those who have
other surplus products themselves.

Limitations of the barter system:

1. Lack of double coincidence of wants
The basic problem in the barter system is the double coincidence of ants. It means that there
must be double satisfaction of wants.
Both parties are in barter. For instance, goods can be exchanged effectively if a person can
spare what the other person wants and at the same time needs what the other can spare.

2. Lack of common measure

In a barter system, there is no common measurement for exchangeable goods. For instance, if
a person has a cow and another has a goat, and 1st wants to exchange cow after receiving two
goats, and the other does not agree from 1st because there is no common measurement of goods.

3. Lack of store value

In a barter system, there is no facility for storing value. Because some goods have no storage
facility. Like vegetables, fruits, etc

4. Lack of capital formation

The formation of capital goods is necessary for further production of goods and services. The
basis of capital formation is saving. In the absence of capital formation, the economic progress
becomes zero.

5. Difficulties in tax collection

In barter, tax is collected by the revenue department in the form of commodities. The goods
collected from the payer will not be stored for a longer period. They will lose their value with
time.

6. Difficulties in the transfer of wealth

There is great difficulty in transferring wealth from one place to another under barter. More
ever immovable property can not be transferred.

Concept of money:
Definition:
Money is anything that can be used as a medium of exchange and at the same time act as a
measure and store of value.

Essential functions of money:

1. Medium of exchange:
Money can be used to make payments for all transactions of goods and services. It is the most
essential function of money. Money has the quality of general acceptability that’s why all
exchanges take place in terms of money.

2. Measure of value:
Money provides a common measure of value that allows people to compare and express the
prices of different goods and services consistently.

3. Store of value:
Money acts as a store of value. It provides security to individuals to meet possibilities, and
unpredictable emergencies and to pay future debts. It keeps its value over time, allowing
individuals and businesses to store wealth and make purchases in the future. It is also the store
of wealth.

4. Standard of deferred payment:

Money allows for transactions to occur at a different time than when the agreement is made.
This means that debts and obligations can be expressed and settled in the future, making credit
and borrowing possible.

Types of money:
1. Commodity money:
Commodity money is made up of valuable commodities like wheat, goats, etc. people used
these commodities for exchange purposes and to fulfill their needs. As time passed on, they
faced many problems due to commodity money like storing value, durability, divisibility, etc.

2. Metallic money or Coins:

The next step in the evolution of money in the payment system is metallic money. Metallic
money is made up of precious metals like gold, silver, and copper. Metallic money was
introduced to overcome the problem of commodity money in terms of quality and quantity.
There were two kinds of metals.
Un-coined Metals:
Metals were not used as coins but as bullion. This creates the problem of measuring the weight
and value.
Coined Metal:
After the failure of uncoiled metals, standard coins were created. They had a standard weight
and value. Problems of un-coined metals are solved by the use of coined metals.

3. Paper Money:
Paper currency is made up of paper and used for payment systems and also used as a medium
of exchange. It consists of notes issued by the state or central bank.
Paper money can be;
Convertible paper money:
It is converted into coins on demand e.g. gold and silver certificates.
Fiat paper money:
It is not converted into coins on demand and it is accepted in transactions at its face value due
to its unlimited legal tender.

4. Credit Money or Bank Money/plastic money:

The next step in the evolution of money in the payment system is credit money. It means the
use of different instruments (cheques) issued by the bank as a medium of exchange. The
advantage of bank money is that they are easy and safe to transport for payment purpose.

5. Electronic Money:
The next stage in the development of the payment system is Electronic money replaces credit
or bank money due to the expansion of technology. Electronic money consists of ATMs, debit
cards, credit cards, and online banking. People can make payments and receive money through
the online banking system and save time.
Qualities of good money:
1. General Acceptability:
The most essential quality of an ideal money material is that it would be acceptable as a medium
of exchange without any objection by others for goods and services.

2. Transferability:
Good money has quality of portability means it can be easily and economically transported
from one place to the other. In other words, it possesses high value in small bulk.

3. Durability:
As money is passed from hand to hand and is kept in reserves it must not easily deteriorate
either in itself or as a result of wear and tear.

4. Homogeneity:
All potions of the substance used as money should be homogeneous and of the same quality so
that equal weights have the same value. Its units must be similar in all respects.

5. Divisibility:
The money material should be capable of division and the aggregate value of the mass after
division should be almost the same as before.

6. Recognizability:
One of the very essentials of good money material is that it should be easily recognizable by
the eye, ear, or touch. It should have certain distinct marks which nobody can mistake.

7. Stability of Value:
Money should not be subject to fluctuations in value. The value of a material which is used to
measure the value of all the other materials must be stable.

Methods of note issuing:

1. Fixed fiduciary system:
Under this method of note issue, the central bank of the country is allowed to issue currency
notes of a specified amount without presenting gold and silver to cover it. Once this limit is
reached, an additional amount of notes can be issued by 100% backed by gold.

2. Maximum fiduciary system:

According to this method of note issue, the fiduciary system limit is fixed above the normal
requirement of the country. Beyond the maximum, no note is issued without legal sanction.

3. Proportional reserve system:

Under this method of note issue, the central bank is mandatory by law to maintain a permanent
percentage from 25 % to 40 % adjacent to the issuance of notes. It is often called a percentage
system.

4. Minimum reserve system:

Under this method if note issue, the reserve limit is permanently fixed and the volume of notes
has no connection with the amount of reserve.