Question

In: Economics

1. Explain what inflation is and how it is measured. 2. Explain the two types of...

1. Explain what inflation is and how it is measured.


2. Explain the two types of inflation and describe the cost of inflation.

Solutions

Expert Solution

(1)

Inflation is the scenario of price increase for the goods and commodities. It weakens the purchasing power of people in the economy. The price of goods and services during the inflation tends to be more than the equilibrium price. During inflation the amount of monetary people having will be the same, but the value and the commodities purchasable using such money will be less. Inflation could either be treated as a positive or a negative thing according to the needs of each individual. Fixed assets value would be increased due to the increase in price but the value for liquid cash won't rise. Central government intervenes when the inflation gets at its peak and formulate its Fiscal and Monetary policy to protect the economy and bring it back to its normality.

In most of the countries Inflation is measured using the CPI ( Consumer Price Index ) as it will measure the value and price for a basket of commodity in the current year with the same basket of commodity with the previous year. Consumer Price Index is the ratio of the cost of commodities in the current year to the cost of purchase of the same basket in the base year. It is generally expressed in percentage terms.

CPI = cost of basket of commodities in the current year / cost of the same commodities in the base year * 100

(2)

Inflation may be classified in a variety of ways.

(A) Classification on the basis of production and supply

(a) Production Inflation : When production falls there is disequilibrium in supply and demand for money. As a result production inflation rises.

(b) Profit Inflation : Due to intervention on some other causes, cost of production falls. But prices are not reduced. Hence profits are increased.

(B) On the basis of speed of inflation

(a) Walking Inflation : The price level under walking inflation rises by 5% annually.

(b) Galloping ( hyper ) inflation : In fact, this is the most dangerous type of inflaion. Here the price rises every minute. There is no upward limit to which the price may rise in courses of time.

Cost of Inflation : Inflation is very dangerous for the economy as it will destroy the purchasing power of money. It will affect the GDP of the nation. Value of liquid cash will decline. People's interest in making investment will also tend to decline.


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