3/28/2024 ASSIGNMENT ON MANAGERIAL

ECONOMICS

SUBMITTED BY H. LALMUANPUIA
ROLL NO: 7 , II SEMESTER
SUBMITTED TO: DEBOJIT RABHA
INFLATION
We come across the term inflation very often in newspapers. The reason why it holds
such importance is because of its adverse effects on an economy as well as people. A
question that could arise at this point is in what way does inflation affect our everyday
life? Let us illustrate with the help of a single household. Inflation, in simple words, is
a steady rise in the prices of various goods and services. Given the level of the money
income, a household consumes a group of commodities at a given price level. With
inflation, the price level goes up. So with the same level of money income, the
household could consume a smaller amount of the commodities than it was
consuming earlier. Alternately, to maintain the earlier level of consumption this
household now needs to have more money.
“Inflation is a rise in prices, which can be translated as the decline of purchasing
power over time. The rate at which purchasing power drops can be reflected in the
average price increase of a basket of selected goods and services over some time. The
rise in prices, which is often expressed as a percentage, means that a unit of currency
effectively buys less than it did in prior periods. Inflation can be contrasted with
deflation, which occurs when prices decline and purchasing power increases.”
For example, suppose the household has a monthly income of Rs.100, consumes the
entire income on a single commodity A and does not save anything. If the price of
commodity A is assumed to be Rs. 4 then the household consumes 25 units of A in a
month. Now suppose, the price of commodity A goes up from Rs.4 to Rs.5. The
household will be able to consume only 20 units of commodity A. To maintain the
level of consumption at 25 units of A per month, the household needs to have a
monthly income of Rs. 125. Thus, we see that with inflation, one unit of money
purchases a smaller amount of goods than it was doing earlier. In other words, with
inflation, purchasing power of money goes down. In the above example, consumption
of the household comprises one commodity only. But for a typical household,
consumption involves a variety of goods and services. As a result, increase in the price
of one commodity need not affect household consumption adversely if there is a
decline in the price of some other good. Therefore, to ascertain the effect of inflation
we need to take into account the change in the prices of all the goods consumed by the
household. To do that, we need to find the change in the general level of prices.
Therefore, before defining inflation we discuss the meaning of price level and the
changes in it.
MEASUREMENT OF PRICE LEVEL
The term price level is an aggregate concept. It relates to the price of a basket of goods
and services. See that we do not refer to the price of a single commodity but to a
group of goods and services taken as a whole. Therefore, when we talk of a change in

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the price level it is always in reference to a group of commodities. Since the prices of
commodities differ, in order to measure a change in the price level of a group of
commodities, it is necessary to use index numbers. More specifically, we have to use
price index. Let us understand the idea of an index number in an elementary form.

Definition of Index Number

An index number is a concept which enables us to compare the changes in a group of
distinct, but related, variables in two or more time periods. A price index is used for
comparing changes in the general level of prices of a group of commodities. Generally
a price index refers to changes in the prices obtained over time. It is expressed by
putting a particular period (called the ‘base period’) equal to 100 and the price level
for other periods are expressed relative to this base. For example, when we say, the
wholesale price index has gone up this year with respect to last year, we are taking last
year price level as the base or, the reference point = 100. With respect to it we measure
the change in the price level this year. The price relative of an individual item is the
ratio of its current price to its price in a base period. The simplest price index for a
given commodity can be expressed as
I t,o = 100 (pt / po )
where pt and po denote prices in the current period ‘t’ and the base period ‘0’
respectively. For instance, if price of a kilo of potato goes up from Rs. 8 in 2017 to Rs.
10 in 2018, then the price index in this case would be:
I2017,2018 = 100 (10/8) = 125
This index shows a 25 per cent increase in the price of potato over the year. In other
words, you need 25 per cent more money to maintain your consumption of potatoes at
the same old level.

TYPES OF INFLATION
1. Demand-Pull Inflation: This type of inflation occurs when aggregate demand
exceeds aggregate supply. When consumers have more disposable income or
access to credit, they increase their spending, leading to increased demand for
goods and services. As producers struggle to keep up with demand, they may
raise prices, causing inflation.
2. Cost-Push Inflation: Cost-push inflation is driven by increases in production
costs, such as wages or raw materials. When businesses face higher costs of
production, they may pass these costs onto consumers by raising prices. This

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 can lead to a decrease in consumer purchasing power and a general rise in the
price level.
3. Built-In Inflation: Also known as wage-price inflation, built-in inflation
occurs when workers negotiate higher wages to compensate for past increases
in the cost of living. When wages rise, businesses may increase prices to
maintain profit margins, leading to a cycle of wage-price increases.
4. Hyperinflation: Hyperinflation is an extreme form of inflation characterized
by rapidly increasing prices, often spiraling out of control. It typically occurs
when a government excessively prints money to meet its financial obligations,
leading to a loss of confidence in the currency and a collapse of the economy.
Monetary Policy
Definition: Monetary policy refers to the actions taken by a central bank to control the
money supply and influence interest rates in order to achieve macroeconomic
objectives such as price stability, full employment, and economic growth.
Tools:
1. Interest Rates: Central banks use interest rates as their primary tool for
monetary policy. By raising or lowering short-term interest rates, central banks
can influence borrowing and spending behavior in the economy. Lowering
interest rates encourages borrowing and investment, stimulating economic
activity, while raising interest rates can help control inflation by reducing
spending.
2. Open Market Operations: Central banks conduct open market operations by
buying or selling government securities in the open market. When the central
bank buys government securities, it injects money into the banking system,
increasing the money supply and lowering interest rates. Conversely, selling
government securities reduces the money supply and raises interest rates.
3. Reserve Requirements: Central banks require commercial banks to hold a
certain percentage of their deposits as reserves. By adjusting reserve
requirements, central banks can control the amount of money that banks can
lend. Lowering reserve requirements increases the money supply, making it
easier for banks to lend, while raising reserve requirements decreases the
money supply, making it more difficult for banks to lend.
Fiscal Policy

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Definition: Fiscal policy refers to the use of government spending, taxation, and
borrowing to influence economic conditions, stabilize the economy, and achieve
specific macroeconomic objectives.

Tools:
1. Government Spending: Governments can influence aggregate demand by
changing their levels of spending on goods and services. Increasing
government spending, particularly on infrastructure projects or social
programs, can stimulate economic activity and create jobs. Conversely,
reducing government spending can help control inflation by reducing aggregate
demand.
2. Taxation: Tax policy can affect consumer and business behavior by influencing
disposable income and incentives to work, save, and invest. Cutting taxes can
stimulate consumption and investment, leading to increased economic activity.
Conversely, raising taxes can reduce disposable income and dampen consumer
spending, helping to control inflation by reducing aggregate demand.
3. Borrowing: Governments can borrow funds through the issuance of bonds to
finance expenditure or investment projects. Borrowing can help stimulate
economic activity by injecting funds into the economy, particularly during
times of recession or economic downturn. However, excessive government
borrowing can lead to higher interest rates and crowd out private investment,
potentially leading to inflationary pressures.
Both monetary and fiscal policies are essential tools used by policymakers to manage
economic conditions and achieve macroeconomic stability. They often work in
concert, with monetary policy focusing on managing the money supply and interest
rates, while fiscal policy focuses on government spending, taxation, and borrowing.
By coordinating these policies effectively, policymakers can address various economic
challenges such as inflation, unemployment, and economic growth, and promote long-
term prosperity.
Causes of Inflation
Inflation can stem from various factors, both demand-side and supply-side, and it's
often a combination of these factors that contribute to rising prices. Here are some
common causes of inflation:
Demand-Pull Factors:

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 1. Increase in Aggregate Demand: When aggregate demand (the total demand
for goods and services in an economy) exceeds aggregate supply, it can lead to
inflation. This scenario often occurs during periods of robust economic growth,
increased consumer confidence, or expansionary fiscal or monetary policies
that stimulate spending.
2. Consumer Spending: If consumers increase their spending due to factors like
rising incomes, increased consumer confidence, or easy access to credit, it can
drive up demand for goods and services, leading to inflationary pressures.
3. Government Spending: Increased government expenditure, particularly on
programs like infrastructure development or defense, can boost overall demand
in the economy and contribute to inflation if it outpaces the economy's capacity
to produce goods and services.
Cost-Push Factors:
1. Rising Production Costs: When the costs of production increase, such as
wages, raw materials, or energy costs, producers may pass on these higher costs
to consumers by raising prices. This cost-push inflation can occur
independently of changes in demand, leading to a decrease in the purchasing
power of money.
2. Supply Shocks: Events that disrupt the supply of key goods or resources, such
as natural disasters, geopolitical conflicts, or trade disruptions, can lead to
sudden increases in prices due to supply shortages. These supply shocks can
cause inflation by reducing the availability of goods and driving up their prices.
Built-In Factors:
1. Wage-Price Spiral: When workers demand higher wages to keep up with
rising prices, it can lead to a cycle of wage-price increases. As businesses raise
prices to cover higher labor costs, workers may demand further wage increases,
perpetuating inflationary pressures.
2. Inflation Expectations: Expectations of future inflation can become self-
fulfilling prophecies if consumers and businesses anticipate rising prices and
adjust their behavior accordingly. For example, consumers may purchase goods
and services sooner to avoid higher future prices, leading to increased demand
and inflation.
Monetary Factors:
1. Excessive Money Supply Growth: When the money supply expands at a
faster rate than the growth of real output in the economy, it can lead to excess

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 liquidity, which fuels inflationary pressures. This situation often occurs when
central banks pursue expansionary monetary policies, such as lowering interest
rates or engaging in quantitative easing.
2. Monetary Policy Mismanagement: Inflation can result from inadequate or
inconsistent monetary policy actions by central banks. If policymakers fail to
respond effectively to changing economic conditions or if there is a loss of
credibility in the central bank's commitment to price stability, it can lead to
inflationary expectations and actual inflation.
External Factors:
1. Exchange Rate Changes: Depreciation of the domestic currency relative to
foreign currencies can increase the cost of imported goods and services, leading
to imported inflation. This effect is particularly significant for countries heavily
reliant on imports or with high levels of foreign debt.
2. Global Commodity Prices: Fluctuations in global commodity prices, such as
oil, food, or metals, can impact domestic inflation rates, especially for
economies that are net importers of these commodities. Increases in global
commodity prices can raise production costs and contribute to inflationary
pressures domestically.