Demand Pull Inflation

Inflation

What is inflation?

Inflation is defined as a continuous increase in the price level of goods and services along with a decrease in the purchasing power of the money. It is measured as an annual percentage increase with respect to a standard.

Causes of inflation:

There are many causes of inflation; some of them are as follows:

1. Demand Pull Inflation:

This sort of inflation occurs when aggregate demand is more than the aggregate supply leading to decrease in unemployment (as per the Phillips curve).

This theory can be summarized as "large sum of money purchasing few goods". In other words, the growth in demand is much faster than growth in supply and price rise is continuous. This is usually a scenario observed

There has been a huge criticism associated with this sort of inflation because an increase in the cost of goods, raw materials and services does not lead to an inflationary scenario. The statement presented against is that if money supply is constant then with a rise in the prices of raw materials and goods, the money available for purchasing other goods and services will reduce. This creates an offsetting case for those goods whose prices had increased.

3. Monetary Expansion

Monetary policy is the process which the central bank uses for controlling the economy by affecting the interest rate. The monetary policy as controlled by RBI in INDIA could either be contractionary or expansionary. Many times the expansionary monetary policy leads to an increase in the money supply which indirectly leads to increase in disposable income, increasing the demand of goods and services and ultimately to price rise. Money supply could be in terms cash, loans and mortgages. Cheap loans at lower interest rates are like fuel in the scenario and cause

CPI- It stands for consumer price index. It is a comprehensive measure and is employed for the estimation of price variations in goods and services that represent the consumption expenditure in an economy. It involves a tedious calculation for estimation of inflation. Consumption items have been segregated into different categories and even the rural population’s consumption basket weightage is different from the urban population’s basket of goods and services.

It involves basically two types of data- weight and price. The index can be computed monthly or quarterly.

Some of the weights are

National statistic agencies are the ones involved in further calculating the inflation from the parameters.

The RBI has recently shifted the base of inflation measurement in INDIA from WPI to CPI.

2. WPI- Wholesale Price Index (WPI) which has been the benchmark for inflation measurement in INDIA till 2014 represents good’s price at wholesale stage i.e. the impact on cost of living of an average INDIAN was ignored but the focus was on bulk transactions. WPI is easier when compared to CPI in terms of the efforts required in estimating the inflation. Inflation rate is the difference between WPI calculated at the beginning and the end of a year. The percentage change in WPI for a year gives the rate of inflation for that particular year.

There are 240 commodities which are used in the calculation of