Very Short Question Answer

1.  What is meant by inflation?

Inflation is a persistent and appreciable rise in general price level or decline in the value of money. It implies that there exist inverse relationship between price level and value of money.

2. How many types of inflation on the basis of speed?

On the basis of speed, inflation is divided into following four types:

i. Creeping inflation
ii. Walking inflation
iii. Running inflation
iv. Hyper inflation

3. Distinguish between open and suppressed inflation.

If there is no control on the rising in price level by the government, it is called open inflation. On the other hand, if there is control on the rising in price level by the government, it is called suppressed inflation.

4. Define stagflation.

When there is simultaneous existence of high rate of inflation and unemployment, it is called stagflation.

5. Distinguish between partial and full inflation.

When price level rises before full employment with the increase in money supply, it is called partial inflation. On the other hand, when price level rises after full employment with increase in money supply, it is called full inflation.

6. What do you mean by demand pull inflation?

When aggregate demand for goods and services exceeds the supply of these goods and services, price level rises, which is known as demand pull inflation.

7. What do you meant by cost push inflation?

When price level rises due to the increase in cost of production, it is called cost push inflation. In other words, the cost push inflations is caused by the monopoly power exercised by some monopoly groups of the society, like labour union and firms in monopolistic or oligopolistic market.

Short Question Answer

1. Define inflation. What are the different types of inflation?

Inflation is defined as the persistent rise in the general price level which causes a decline in the purchasing power of money. But each and every rise in general price level cannot be termed as inflation in the true sense. According to Keynes, in true sense, inflation starts only after the state of full employment.
According to monetarist, inflation is purely monetary phenomenon, i.e. it occurs due to excess money supply.

There are different types of inflation which can be classified as follows:

i. On the basis of Speed: On the basis of speed, inflation is divided into creeping, walking, running and hyper inflation.

⦁ Creeping inflation: When the annual rate of inflation is up to 3 percent, it is called creeping inflation. It has no negative impact on the economy.

⦁ Walking inflation: When the rate of rise in price level is in the range of 3 to7 percent per-annum or less than 10 percent, it is called walking inflation.

⦁ Running inflation: When the price level rises at a rate of speed of 10 to 20 percent per annum, it is called running inflation. It affects the poor and middle classes people adversely.

⦁ Hyper inflation: When price level rises more than 20 percent per annum. It is called hyper inflation. This is the last stage of inflation which starts after the full-employment level is reached.

ii. On the basis of Time: On the basis of time inflation is classified as follows:

⦁ Peace time inflation: Peace time inflation, refers to the rise in price level during normal time period.

⦁ War time inflation: In the war time, unproductive government expenditure increases which in turn, price level rises. It is known as war time inflation.

⦁ Post war inflation: The inflation occurred after the war is called post war inflation.

iii. On the basis of Scope: On the basis of scope inflation can be classified as follows:

⦁ Comprehensive inflation: When the prices of all goods and services increase throughout the economy, it is known as comprehensive inflation.

⦁ Sporadic inflation: When the price rises only in some sectors of the economy, it is called sporadic inflation. It is also known as sectoral inflation because it affects a few sectors of the economy but not whole economy.

iv. On the basis of Government Reaction/ On the basis of Nature: On the basis of government reaction, inflation is classified as follows:

⦁ Open inflation: If the government does not make any effort to control the price rise and the market mechanism is allowed to function without any intervention, it is known as open inflation.

⦁ Suppressed inflation: If the government checks the price rise through price control and rationing, it is called suppressed, inflation

v. On the basis of causes: Inflation is caused by two factors due to the increase in effective demand and due to increase in cost of production. The inflation caused by the increase in demand known as demand pull inflation. On the other hand, the inflation caused by the increase in cost of production is known as cost push inflation.

2. What is inflation? Explain its economic effects.

Please refer to Q. No. 1.

Mild inflation has positive effects in the economy. But when hyper inflation occurs in the economy, it has negative effects. It creates business uncertainty, which is unfavorable to production. The economic effects of inflation are as follows:

i. Effects on production activities: Inflation causes decline in value of money. Due to the decline in value of money, expenditure increases and saving. decreases. The capital formation is also reduced. Consequently, the investment decreases and the unemployment increases. It also discourages foreign capital and encourages the speculative activities as well as hoarding of commodities. During hyper inflation, the productive resources divert from the industries producing necessary goods to the industries producing luxury goods. Consequently, there will be shortage of necessary goods. And also businessmen reduce the quality of the products to earn more profit.

ii. Effects on output and employment: Creeping inflation will have tonic effect on output and employment in an economy. Therefore, most economists agree that inflation increases employment and output, An extremely rapid inflation may at first stimulate production and reduce unemployment. But finally it reduces production and increases unemployment than before. On the other hand, a moderate inflation will stimulate production and increases employment without generating any that come with a sharp rise in prices

iii. Effects on economic growth: The rate at which an economy’s output grows over the long run is the rate of economic growth. There is controversy, whether inflation promotes economic growth or not. In many countries, the positive relationship is found between inflation and economic growth. In time of inflation, the resources are shifted from the production of necessary goods to the production of capital goods. When the capital accumulation takes place rapidly, the productive capacity and productivity will increase. Consequently, there is rapid economic growth for a long time. Further, according to some economists, inflation discourages saving and decreases the capital formation. As capital formation declines, investment also declines. Due to this the productive capacity and the productivity will decline. As a result, there is low economy growth.

iv. Effects on distribution: During inflation, the cost of living increases rapidly. So, inflation severely hurts that group of people, who have fixed income like salary and wage earners. It is beneficial to the entrepreneurs, producers and traders. They experience windfall gains. The debtors are in gain because the purchasing power of money falls during inflation. But the creditors are in loss because the real value of income declines during inflation. Similarly, the investors on equities are in gain because the dividends increase with the rise in price. The investors on bond and debentures are in loss because the returns are fixed.

2. Explain the deflation and stagflation.

Deflation is the opposite of inflation. It is defined as the situation of fall in general price level or increase in value of money. According to Crowther, “Deflation is that state of the economy where the value of money is rising or the prices are falling.” Thus, deflation is associated with falling prices, but each and every fall in price will not be termed as deflation. Only those falls in prices which result in unemployment, over production and fall in the economic activity…. are deflationary. In short, deflation is accompanied by falling employment level. output and income. The main causes of deflation are fall in money supply and bank credit; and sudden rise in output.

Stagflation is defined as the situation where a high rate of inflation occurs simultaneously with a high rate of unemployment. The existence of a high rate of unemployment means the reduced level of GNP. The terms stagflation was coined in 1970s when several developed countries of the world received a supply stock. In terms of rapid hike in oil prices in 1973, the cartel of oil producing countries (OPEC) raised the price of oil. There was a four times increase in the oil prices. In the United States during 1973-75, the higher cost of fuel-oil and other petroleum product brought a sharp increase in the prices of manufactured goods. The rate of inflation went up to over 12 percent during 1974 in USA. A severe recession, the worst since 1930s, also hit the American economy during the period 1973-75. The real GNP declined between the late 1973 and early 1975. As a result, the rate of unemployment increased up to nearly 9 percent. Thus, both inflation and unemployment were usually very high during period 1973-1975 which simultaneous occurrence of high inflation and high unemployment was also seen in case of other free market developed courtiers such as Britain, French and Germany. The recovery from recession began in 1975 and over the next few years GNP rose and unemployment declined. Inflation rate also declined from over 12 percent to the range of 5 to7 percent. Again, in 1979, Iran revolution created a crisis in the world oil market. OPEC doubled the price of oil. This brought back stagflation again in 1979 in the developed countries. Real GNP declined at a rapid rate during 1979-81. Inflation rate again went up to over 10 percent in these countries.

3. What is inflation? Suggest the measures to control Inflation.

Please refer to Q. No.1.

Inflation affects the economy as a whole seriously. It occurs due to the excessive supply of money, excessive expenditure and scarcity of goods. Hence, the measures to control inflation are directed towards reducing the money supply and expenditures and increasing production. The measures to control inflation are as follows:

i. Monetary Measure: Monetary policy is adopted to influence the money supply and credit by changing interest rate and availability of credit by the central bank. Various measures to control inflation are as below:

a. Increase in bank rate: Bank rate is the rate at which the central bank lends money to the commercial bank. An increase in the bank rate leads to an increases in the interest rate charged by the commercial banks. It discourages borrowing. This will reduce money supply with public and thus control the inflationary pressure.

b. Open market operation: Under this method, the central bank sells the government securities to people. People buy the securities by withdrawing deposits from banks. This reduces the cash reserve with banks. Consequently, their credit creation power also diminishes. But if the banks increase their cash reserve by selling their securities to the central bank, the open market operation may be ineffective.

c. Increase in cash reserve: The commercial banks should keep certain portion of their deposit with the central bank as cash reserve. If the cash reserve ratio is increased, the power of the banks to create credit is reduced. Hence, the central bank increases the cash reserve ratio to control inflation. But this policy may fail if the banks have large excess reserve.

d. Consumer credit control: This method helps to curb excessive spending from consumers. In the advanced countries, durable goods are purchased on installment credit. During inflation, loan facilities for installment buying are reduced to minimum to check consumption spending.

e. Higher margin requirement: Margin requirement is the difference between the market value of the security and its maximum loan value. A bank does not advance loan equal to the market value of the security, but less. During inflation, the margin requirement can be raised to reduce the loan that one can get on a security.

f. Fiscal measures: The policy related to public expenditure, public revenue and public debt is known as fiscal policy. The instruments of fiscal policy used to control inflation are as follows:

Reduction in public expenditure: During inflation, effective demand is very high due to expansion of public and private spending. In order to check inflation, the government should reduce unnecessary expenditure on non-development activities. It will be helpful in controlling inflation.

Increase in taxation: The tax determines the disposable income. Hence, the existing tax rates should be increased to reduce consumption and new taxes should be imposed without restricting production. It will help to control inflation.

⦁ Public borrowing: The government can take voluntary or forced loan from people to reduce the additional purchasing power with them. The countries like Britain, Belgium, Holland and Norway had taken forced loan in the past. But the forced loan is not practical in peacetime democratic countries. But the government can take voluntary loan from people by providing attractive interest, security and liquidity.

⦁ Control of deficit financing: Deficit financing means excess of government expenditure over its revenue by printing of new currency. In order to control inflation, the government should minimize deficit financing.. The deficit should be financed through saving or taxation as for as possible. The government can sell bonds to non-bank investors like insurance companies, saving banks, etc. It will take away the purchasing power from the public and thus check inflation.

⦁ Debt management: The government should stop repayment of public debt and postpone it to the future date till inflationary pressures are controlled. Instead, the government should borrow more to reduce money supply with the public. It will be helpful to control inflation.

ii. Direct controls on prices: Under direct controls there are two measures to control inflation:

a. Direct controls on prices: Under this, the upper limit of price is fixed beyond which the price is not allowed to rise and inflation is suppressed up to that limit.

b. Rationing: When the government fixes the quota of certain goods, it is called rationing. Rationing is used in case of essential consumer goods which are relatively scarce. The purpose of rationing is to divert consumption from the goods whose supply needs to be restricted for some special reason.

iii. Other measures: Besides monetary, fiscal, direct measures, there are some other measures to control inflation, which are expansion of output, proper wage policy, encouragement of saving and overvaluation of domestic currency.

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