Inflation: Meaning and Types

In economics, inflation is defined a sustained increase in the general price level of goods and
services in an economy over a period of time. It is measured as an annual percentage increase. When the
general price level rises, each unit of currency buys fewer goods and services. This implies that inflation
reflects a reduction in the purchasing power per unit of money. In other words, inflation indicates a loss of
real value in the medium of exchange and unit of account in the economy.
Different definitions of inflations have been given by different Economists some of which are as
follows:
1. In the words of Peterson, “The word inflation in the broadest possible sense refers to any
increase in the general price-level which is sustained and non-seasonal in character.”
2. According to Coulborn inflation can be defined as, “too much money chasing too few goods.”
3. According to Samuleson-Nordhaus, “Inflation is a rise in the general level of prices.
4. As per Johnson, “Inflation is an increase in the quantity of money faster than real national
output is expanding”.
5. Keynes has presented his view that true inflation is the one in which the elasticity of supply of
output is zero in response to increase in supply of money.

Types of inflation
Inflation is usually categorized on different basis which are given as below:
A. On the basis of Rate: Inflation has been categorized into following types on the basis of its different
rates:
1. Creeping Inflation: Creeping Inflation also known as a Mild Inflation or Low Inflation refers
to that type of inflation when the rise in prices is very slow like that of snail or creeper. It is the mildest
form of inflation with less than 3% per annum.
2. Chronic Inflation: If creeping inflation persist for a longer period of time then it is often called
as Chronic or Secular Inflation. It is called chronic because if an inflation rate continues to grow for a
longer period without any downturn which may possibly lead to Hyperinflation.
3. Walking or Trotting Inflation: When prices rise moderately with a single digit of less more
than 3% but less than 10% per annum it is called as Walking Inflation.
4. Running Inflation: A rapid acceleration in the rate of rising prices is referred as Running
Inflation. This type of inflation occurs when prices rise by more than 10% per annum.
5. Galloping Inflation: Galloping inflation also known as Jumping inflation occurs when prices
rise by double or triple digit inflation rates of more than 20% but less than 1000% per annum.
6. Hyperinflation: when prices rise at an alarming high rate with quadruple or four digit inflation
rate of above 1000% per annum then is termed as Hyperinflation. It is a situation where the prices rise so
fast that it becomes very difficult to measure its magnitude. During a worst case scenario of
hyperinflation, value of national currency of an affected country reduces almost to zero. Paper money
becomes worthless and people start trading either in gold and silver or sometimes even use the old barter
system of commerce. Two worst examples of hyperinflation recorded in world history are of those
experienced by Hungary in year 1946 and Zimbabwe during 2004-2009 under Robert Mugabe's regime.

B. On the basis of Causes: Inflation has been categorized into following types on the basis of its different
causes:
1. Demand-Pull Inflation: Demand-Pull Inflation also known as Excess Demand Inflation takes
place when aggregate demand for a good or service outstrips aggregate supply. In other words, when
aggregate demand for all purposes- consumption, investment and government expenditure-exceeds the
supply of goods at current prices then it is called Demand-Pull Inflation. Demand-Pull inflation gives rise
to a situation often economists describe as “Too much money chasing too few goods”.
2. Cost-Push Inflation: When prices rise due to growing cost of production of goods and services
then it is known as Cost-Push Inflation. Cost-push inflation also came to known as “New Inflation” is
determined by supply-side factors mainly caused by higher wage-push, Profit-Push and higher costs of
raw materials.
3. Scarcity Inflation: Scarcity inflation occurs due to hoarding by unscrupulous traders and black
marketers so as to create an artificial shortage of essential goods like food grains, kerosene,etc. with an
intension to sell them only at higher prices to make huge profits.
4. Structural Inflation: Structural inflation is that type of inflation often experienced in
developing countries which is caused by structural rigidities such as agricultural bottlenecks, resource
constraints bottlenecks, foreign exchange bottlenecks, physical infrastructural bottlenecks etc.

C. On the basis of Coverage: Inflation has been categorized into following types on the basis of its
coverage:
1. Comprehensive Inflation: When the prices of all commodities rise throughout the economy it
is known as Comprehensive Inflation also known Economy Wide Inflation.
2. Sporadic Inflation: When prices of only few commodities in few regions rise, it is known as
Sporadic Inflation. It is sectional in nature. For example, rise in food prices due to bad monsoon
represents this type of inflation.

D. On the basis of Occurrence: Inflation has been categorized into following types on the basis of its
time of occurrence:
1. War-Time Inflation: when inflation that takes place during the period of a war-like
situation then it is known as War-Time inflation. During a war, scare productive resources are all diverted
and prioritized to produce military goods and equipments resulting in extreme shortage of resources use
producing essential commodities. Consequently, prices of essential goods keep on rising in the market
resulting in War-Time Inflation.
2. Post-War Inflation: Inflation that takes place soon after a war is known as Post-War Inflation.
After the war, government controls are relaxed, resulting in a faster hike in prices than what experienced
during the war.
3. Peace-Time Inflation: When prices rise during a normal period of peace then it is known as
Peace-Time Inflation. It is due to huge government expenditure or spending on capital projects of a long
gestation period.

E. On the basis of Government Reaction: Inflation has been categorized into following types on the
basis of Government's degree of reaction:
1. Open Inflation: When government does not attempt to restrict inflation, it is known as Open
Inflation. In a free market economy, where prices are allowed to take its own course, open inflation
occurs.
2. Suppressed Inflation: When government prevents price rise through price controls, rationing,
etc., it is known as Suppressed Inflation. It is also referred as Repressed Inflation. However, when
government controls are removed, Suppressed inflation becomes Open Inflation. Suppressed Inflation
leads to corruption, black marketing, artificial scarcity, etc.
 Lesson 2

Unit 3

ABM 601

Measures to Control Inflation

Some of the important measures to control inflation are as follows:

1. Monetary Measures

2. Fiscal Measures

3. Other Measures.

Inflation is caused by the failure of aggregate supply to equal the increase in aggregate demand.
Inflation can, therefore, be controlled by increasing the supplies of goods and services and
reducing money incomes in order to control aggregate demand.

The various methods are usually grouped under three heads: monetary measures, fiscal measures
and other measures.

1. Monetary Measures:
Monetary measures aim at reducing money incomes.

(a) Credit Control:

One of the important monetary measures is monetary policy. The central bank of the country
adopts a number of methods to control the quantity and quality of credit. For this purpose, it
raises the bank rates, sells securities in the open market, raises the reserve ratio, and adopts a
number of selective credit control measures, such as raising margin requirements and regulating
consumer credit. Monetary policy may not be effective in controlling inflation, if inflation is due
to cost-push factors. Monetary policy can only be helpful in controlling inflation due to demand-
pull factors.

(b) Demonetisation of Currency:

However, one of the monetary measures is to demonetise currency of higher denominations.
Such a measures is usually adopted when there is abundance of black money in the country.

(c) Issue of New Currency:

The most extreme monetary measure is the issue of new currency in place of the old currency.
Under this system, one new note is exchanged for a number of notes of the old currency. The
value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an
excessive issue of notes and there is hyperinflation in the country. It is a very effective measure.
But is inequitable for its hurts the small depositors the most.

2. Fiscal Measures:
Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented
by fiscal measures. Fiscal measures are highly effective for controlling government expenditure,
personal consumption expenditure, and private and public investment.

The principal fiscal measures are the following:

(a) Reduction in Unnecessary Expenditure:

The government should reduce unnecessary expenditure on non-development activities in order
to curb inflation. This will also put a check on private expenditure which is dependent upon
government demand for goods and services. But it is not easy to cut government expenditure.
Though this measure is always welcome but it becomes difficult to distinguish between essential
and non-essential expenditure. Therefore, this measure should be supplemented by taxation.
(b) Increase in Taxes:
To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes
should be raised and even new taxes should be levied, but the rates of taxes should not be so high
as to discourage saving, investment and production. Rather, the tax system should provide larger
incentives to those who save, invest and produce more.

Further, to bring more revenue into the tax-net, the government should penalise the tax evaders
by imposing heavy fines. Such measures are bound to be effective in controlling inflation. To
increase the supply of goods within the country, the government should reduce import duties and
increase export duties.

(c) Increase in Savings:

Another measure is to increase savings on the part of the people. This will tend to reduce
disposable income with the people, and hence personal consumption expenditure. But due to the
rising cost of living, people are not in a position to save much voluntarily.

Keynes, therefore, advocated compulsory savings or what he called „deferred payment‟ where
the saver gets his money back after some years. For this purpose, the government should float
public loans carrying high rates of interest, start saving schemes with prize money, or lottery for
long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-
pension schemes, etc. All such measures increase savings and are likely to be effective in
controlling inflation.

(d) Surplus Budgets:

An important measure is to adopt anti-inflationary budgetary policy. For this purpose, the
government should give up deficit financing and instead have surplus budgets. It means
collecting more in revenues and spending less.
(e) Public Debt:
At the same time, it should stop repayment of public debt and postpone it to some future date till
inflationary pressures are controlled within the economy. Instead, the government should borrow
more to reduce money supply with the public.

Like monetary measures, fiscal measures alone cannot help in controlling inflation. They should
be supplemented by monetary, non-monetary and non-fiscal measures.

3. Other Measures:
The other types of measures are those which aim at increasing aggregate supply and reducing
aggregate demand directly.

(a) To Increase Production:

The following measures should be adopted to increase production:
(i) One of the foremost measures to control inflation is to increase the production of essential
consumer goods like food, clothing, kerosene oil, sugar, vegetable oils, etc.

(ii) If there is need, raw materials for such products may be imported on preferential basis to
increase the production of essential commodities,

(iii) Efforts should also be made to increase productivity. For this purpose, industrial peace
should be maintained through agreements with trade unions, binding them not to resort to strikes
for some time,

(iv) The policy of rationalisation of industries should be adopted as a long-term measure.

Rationalisation increases productivity and production of industries through the use of brain,
brawn and bullion,

(v) All possible help in the form of latest technology, raw materials, financial help, subsidies, etc.
should be provided to different consumer goods sectors to increase production.
(b) Rational Wage Policy:
Another important measure is to adopt a rational wage and income policy. Under hyperinflation,
there is a wage-price spiral. To control this, the government should freeze wages, incomes,
profits, dividends, bonus, etc.

But such a drastic measure can only be adopted for a short period as it is likely to antagonise
both workers and industrialists. Therefore, the best course is to link increase in wages to increase
in productivity. This will have a dual effect. It will control wages and at the same time increase
productivity, and hence raise production of goods in the economy.

(c) Price Control:

Price control and rationing is another measure of direct control to check inflation. Price control
means fixing an upper limit for the prices of essential consumer goods. They are the maximum
prices fixed by law and anybody charging more than these prices is punished by law. But it is
difficult to administer price control.

(d) Rationing:
Rationing aims at distributing consumption of scarce goods so as to make them available to a
large number of consumers. It is applied to essential consumer goods such as wheat, rice, sugar,
kerosene oil, etc. It is meant to stabilise the prices of necessaries and assure distributive justice.
But it is very inconvenient for consumers because it leads to queues, artificial shortages,
corruption and black marketing. Keynes did not favour rationing for it “involves a great deal of
waste, both of resources and of employment.”

Conclusion:
From the various monetary, fiscal and other measures discussed above, it becomes clear that to
control inflation, the government should adopt all measures simultaneously. Inflation is like a
hydra- headed monster which should be fought by using all the weapons at the command of the
government.
 UNIT – IV

CAPITAL BUDGETING

Capital Budgeting: Capital budgeting is the process of making investment decision in long-term assets or
courses of action. Capital expenditure incurred today is expected to bring its benefits over a period of time.
These expenditures are related to the acquisition & improvement of fixes assets.

Capital budgeting is the planning of expenditure and the benefit, which spread over a number of years.
It is the process of deciding whether or not to invest in a particular project, as the investment possibilities
may not be rewarding. The manager has to choose a project, which gives a rate of return, which is more than
the cost of financing the project. For this the manager has to evaluate the worth of the projects in-terms of
cost and benefits. The benefits are the expected cash inflows from the project, which are discounted against
a standard, generally the cost of capital.

Capital budgeting Techniques:

The capital budgeting appraisal methods are techniques of evaluation of investment proposal will help the
company to decide upon the desirability of an investment proposal depending upon their; relative income
generating capacity and rank them in order of their desirability. These methods provide the company a set of
norms on the basis of which either it has to accept or reject the investment proposal. The most widely
accepted techniques used in estimating the cost-returns of investment projects can be grouped under two
categories.

1. Traditional methods
2. Discounted Cash flow methods
1. Traditional methods

These methods are based on the principles to determine the desirability of an

investment project on the basis of its useful life and expected returns. These methods
depend upon the accounting information available from the books of accounts of the
company. These will not take into account the concept of ‘time value of money’, which
is a significant factor to determine the desirability of a project in terms of present
value.

A. Pay-back period method: It is the most popular and widely recognized traditional method of evaluating
the investment proposals. It can be defined, as ‘the number of years required to recover the original cash out
lay invested in a project’.
According to Weston & Brigham, “The pay back period is the number of years it takes the firm to recover its
original investment by net returns before depreciation, but after taxes”.

According to James. C. Vanhorne, “The payback period is the number of years required to recover initial cash
investment.

𝒄𝒂𝒔𝒉 𝒐𝒖𝒕𝒍𝒂𝒚 (𝑶𝑹)𝑶𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝒄𝒐𝒔𝒕 𝒐𝒇 𝒑𝒓𝒐𝒋𝒆𝒄𝒕

Payback period =
𝒂𝒏𝒏𝒖𝒂𝒍 𝒄𝒂𝒔𝒉 𝒊𝒏𝒇𝒍𝒐𝒘

Merits:

1. It is one of the earliest methods of evaluating the investment projects.

2. It is simple to understand and to compute.

1. It dose not involve any cost for computation of the payback period
2. It is one of the widely used methods in small scale industry sector
3. It can be computed on the basis of accounting information available from the books.

Demerits

1. This method fails to take into account the cash flows received by the
company after the pay back period.

2. It doesn’t take into account the interest factor involved in an investment

outlay.

3. It doesn’t take into account the interest factor involved in an investment

outlay.

4. It is not consistent with the objective of maximizing the market value of

the company’s share.

5. It fails to consider the pattern of cash inflows i. e., the magnitude and timing of cash in flows.

B. Accounting (or) Average rate of return method (ARR):

It is an accounting method, which uses the accounting information repeated by the financial statements to
measure the probability of an investment proposal. It can be determine by dividing the average income after
taxes by the average investment i.e., the average book value after depreciation.
According to ‘Soloman’, accounting rate of return on an investment can be calculated as the ratio of
accounting net income to the initial investment, i.e.,

𝑨𝒗𝒆𝒓𝒂𝒈𝒆 𝒏𝒆𝒕 𝒊𝒏𝒄𝒐𝒎𝒆 𝒂𝒇𝒕𝒆𝒓 𝒕𝒂𝒙𝒆𝒔

ARR= 𝒂𝒗𝒆𝒓𝒂𝒈𝒆 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
× 𝟏𝟎𝟎

𝑇𝑜𝑡𝑎𝑙 𝑖𝑛𝑐𝑜𝑚𝑒 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥𝑒𝑠

Average income after taxes=
𝑛𝑜.𝑜𝑓 𝑦𝑒𝑎𝑟𝑠

𝑡𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Average investment =
2

On the basis of this method, the company can select all those projects who’s ARR is higher than the
minimum rate established by the company. It can reject the projects with an ARR lower than the expected
rate of return. This method can also help the management to rank the proposal on the basis of ARR. A
highest rank will be given to a project with highest ARR, where as a lowest rank to a project with lowest ARR.

Merits

1. It is very simple to understand and calculate.

2. It can be readily computed with the help of the available accounting data.
3. It uses the entire stream of earning to calculate the ARR.

Demerits:

1. It is not based on cash flows generated by a project.

2. This method does not consider the objective of wealth maximization
3. IT ignores the length of the projects useful life.
4. It does not take into account the fact that the profits can be re-invested.

II: Discounted cash flow methods:

The traditional method does not take into consideration the time value of money. They give equal weight age
to the present and future flow of incomes. The DCF methods are based on the concept that a rupee earned
today is more worth than a rupee earned tomorrow. These methods take into consideration the profitability
and also time value of money.
A. Net present value method (NPV)

The NPV takes into consideration the time value of money. The cash flows of different years and valued
differently and made comparable in terms of present values for this the net cash inflows of various period are
discounted using required rate of return which is predetermined.

According to Ezra Solomon, “It is a present value of future returns, discounted at the required rate of return
minus the present value of the cost of the investment.”

NPV is the difference between the present value of cash inflows of a project and the initial cost of the
project.

According the NPV technique, only one project will be selected whose NPV is positive or above zero. If a
project(s) NPV is less than ‘Zero’. It gives negative NPV hence. It must be rejected. If there are more than one
project with positive NPV’s the project is selected whose NPV is the highest.

The formula for NPV is

NPV= Present value of cash inflows – investment.

𝒄𝟏 𝒄𝟐 𝒄𝟑 𝒄𝒏
NPV= + + + (𝟏+𝑲)
𝟏+𝒌 (𝟏+𝒌) (𝟏+𝒌)

Co- investment

C1, C2, C3… Cn= cash inflows in different years.

K= Cost of the Capital (or) Discounting rate

D= Years.

Merits:

1. It recognizes the time value of money.

2. It is based on the entire cash flows generated during the useful life of the asset
3. It is consistent with the objective of maximization of wealth of the owners.
4. The ranking of projects is independent of the discount rate used for determining the present value.

Demerits:
1. It is different to understand and use.
2. The NPV is calculated by using the cost of capital as a discount rate. But the concept of cost of
capital. If self is difficult to understood and determine.
 3. It does not give solutions when the comparable projects are involved in different amounts of
investment.
4. It does not give correct answer to a question whether alternative projects or limited funds are
available with unequal lines.
5. B. Internal Rate of Return Method (IRR)
The IRR for an investment proposal is that discount rate which equates the present value of cash inflows with
the present value of cash out flows of an investment. The IRR is also known as cutoff or handle rate. It is
usually the concern’s cost of capital.

According to Weston and Brigham “The internal rate is the interest rate that equates the present value of the
expected future receipts to the cost of the investment outlay.

The IRR is not a predetermine rate, rather it is to be trial and error method. It implies that one has to start
with a discounting rate to calculate the present value of cash inflows. If the obtained present value is higher
than the initial cost of the project one has to try with a higher rate. Like wise if the present value of expected
cash inflows obtained is lower than the present value of cash flow. Lower rate is to be taken up. The process
is continued till the net present value becomes Zero. As this discount rate is determined internally, this
method is called internal rate of return method.

𝑷𝟏−𝑸
IRR= L+ ×𝑫
𝑷𝟏−𝒑𝟐

L- Lower discount rate

P1 - Present value of cash inflows at lower rate.
P2 - Present value of cash inflows at higher rate.
Q- Actual investment
D- Difference in Discount rates.

Merits:

1. It consider the time value of money

2. It takes into account the cash flows over the entire useful life of the asset.
3. It has a psychological appear to the user because when the highest rate of return projects are
selected, it satisfies the investors in terms of the rate of return an capital
4. It always suggests accepting to projects with maximum rate of return.
5. It is inconformity with the firm’s objective of maximum owner’s welfare.

Demerits:

1. It is very difficult to understand and use.

2. It involves a very complicated computational work.
 3. It may not give unique answer in all situations.

C. Probability Index Method (PI)

The method is also called benefit cost ration. This method is obtained cloth a slight modification of the NPV
method. In case of NPV the present value of cash out flows are profitability index (PI), the present value of
cash inflows are divide by the present value of cash out flows, while NPV is a absolute measure, the PI is a
relative measure.

It the PI is more than one (>1), the proposal is accepted else rejected. If there are more than one investment
proposal with the more than one PI the one with the highest PI will be selected. This method is more useful
incase of projects with different cash outlays cash outlays and hence is superior to the NPV method.

The formula for PI is

𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒇𝒖𝒕𝒖𝒓𝒆 𝒄𝒂𝒔𝒉 𝒊𝒏𝒇𝒍𝒐𝒘

Probability Index =
𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕

Merits:

1. It requires less computational work then IRR method

2. It helps to accept / reject investment proposal on the basis of value of the index.
3. It is useful to rank the proposals on the basis of the highest/lowest value of the index.
4. It is useful to tank the proposals on the basis of the highest/lowest value of the index.
5. It takes into consideration the entire stream of cash flows generated during the useful life of the
asset.

Demerits:

1. It is some what difficult to understand

2. Some people may feel no limitation for index number due to several limitation involved in their
competitions
3. It is very difficult to understand the analytical part of the decision on the basis of probability index.
What is Deflation?

Deflation is a long-term decline in asset and consumer prices. A sustained decline in demand is
what is actually responsible for the widespread deflation. Deflation is also called negative
inflation. When the cost of goods and services rises, it is considered inflation, whereas when
they fall, it is considered deflation.

Deflation

Advantages Of Deflation

Here are several ways the benefits of deflation might be stated:

Enhanced Capacity to Spend: If inflation is negative, or deflation occurs, then currency

appreciates. As a result, consumers have more money to spend and merchants may reduce
their prices.

Monthly Budget: Since commodity prices decline during deflation, consumers can meet their
basic necessities with less money. Thus, it helps those with lower and intermediate incomes by
lowering their monthly outlays.

The Savings Rate Rises: When prices of things drop and consumers spend less money,
deflation sets in and causes them to save more.

Elevated Average Income: Since deflation reduces spending and boosts savings, it aids in
maintaining a higher quality of life.

Helpful to the Debtors: Real debt loads rise as deflation bites. The beneficiaries here are the
debt holders.

Spend Less Money On Running a Business: Deflation reduces the price of doing business by
causing a drop in the cost of inputs including raw materials, equipment, technology, and fixed
assets. Consequently, it is a good time to invest for the long term.

Disadvantages Of Deflation

We may summarise the major disadvantages of deflation as follows:

Lower Spending: Some consumers may cut back on spending on high-end items in the hope
that their prices may drop even more in the near future. Therefore, deflation may lead to less
spending by consumers, which is bad for the economy.
Loss for Investors: During a period of deflation, the value of stock held by investors and
manufacturers is eroded, causing losses for those parties.

Boost the Worth of Debt: Since the value of debt rises in a deflationary economy, it becomes
more difficult for current borrowers to pay off their loans.

Potential for Joblessness: When prices drop, businesses lose money, and as a result, some
of them may go out of business altogether. It might lead to an increase in joblessness.

Reduced GDP: Reduced economic growth and political unpredictability result from reduced
output, decreased consumer spending, rising debt levels, and high unemployment.

Types of Deflation
Many people view deflation as an economic "problem" that might make a recession worse or
trigger a deep recession. There are two types of deflation discussed below:

Strategic Deflation:
When the country implements a monetary policy to reduce the overconsumption of the
population, it causes strategic deflation. In this situation, since the frequency of
overconsumption is reduced, it may help prevent the rise of the market price of products.

Circulation Deflation:
This kind develops as a result of a nation's unpredictable economic circumstances. Circulation
deflation happens when a stable economy is going through a slowdown during its transition
period. Such circumstances will undoubtedly worry the general population. There is also the
manufacture of the same commodities in comparable numbers, which is considered excessive.
Later on, this can lead to a sharp drop in the cost of goods.

What Causes Deflation?

Deflation can occur due to a lot of reasons. A few important reasons are:

Decreased Consumer Demand

When the demand for a product falls, it happens either due to high prices or insufficient product
supply. This leads a business to take decisions like decreasing the prices or reducing the
number of employees. A vicious cycle is caused by deflation. Whenever a business decides to
cut down jobs, it causes a further fall in demand leading to more job cuts. With the fall in
employment, there is a decline in business demand. Businesses have no option but to reduce
prices.
Fall in Production Cost
The production cost goes down whenever the cost of key production input. For example, if
cotton prices have decreased, the production cost of garments will eventually fall. Under such a
scenario, producers might increase production, causing an oversupply of the products. But if the
demand remains unchanged, businesses will need to cut their prices to keep consumers buying
their products.

Supply of Money
If the central bank decides to put strong interest rates in their monetary policies, the people
intend to save their money instead of spending it. This causes a reduction in cash circulation in
the country. In another scenario, deflation can reach significant levels when the money supply
does not rise at the same rate as economic output.

For example, a country makes 100 toys a year with a money circulation of 100 dollars. However,
it now produces 200 toys as a result of economic developments. However, the central bank is
unable to create enough money to be spent on the amount of production. As a result, 200 toys
represent $100. It causes deflation since each toy now costs 0.5 dollars.

Fierce Competition in the Market

Deflation is caused when there is fierce competition in the market among competitors, which
causes aggressive competition in the market. This usually leads them to cut down their prices to
attract more and more customers to make a place in the market.

How does Deflation Impact an Economy?

During inflation, people tend to spend less and save more. On the other hand, the stock market
faces high fluctuations, Which results in strict regulations taken by the government. The
investment behaviour of investors is affected by this, and they tend to make safe and
conservative investments. Favourable investment strategies are either short-term Investments
or tangible Investments. Examples of short-term investments are money market accounts,
short-term mutual funds, peer-to-peer lending, and treasury bonds.

Summary

Deflation refers to a time when prices of products are generally lower, and the value of money is
higher. Deflation is of two types that is strategic deflation and circulation deflation. The causes of
deflation are decreased consumer demand, a fall in production cost, an insufficient supply of
money and fierce competition in the market. Deflation results in a deflation spiral, higher
unemployment, increased debt rates and reduced investment.
Features of capital budgeting

Here are the key features that define the budgeting process features of capital budgeting

Long-term: It involves making long-term investment decisions that will affect your company’s
financial health.

Time-sensitive: It takes into account the time value of money, which means that a dollar today
is worth more than a dollar in the future. It’s like trying to decide whether to eat a cookie now or
wait for two cookies later – you have to consider the value of delayed gratification.

Risk-conscious: Another feature is risk assessment. Businesses must carefully evaluate the
potential risks and rewards of each investment opportunity to make informed decisions.

Predictive: Capital budgeting requires accurate financial forecasting, which involves predicting
future cash flows and expenses.

Needs collaboration: Finally, capital budgeting requires collaboration and communication

among different departments and stakeholders within a company.