Consider a hypothetical situation of two person living in a house with just 2kg of rice and a 10rs coin/note with each other.
now if you calculate the price of a kg of rice here it will be (Rs10 + Rs10)/2(as 2 kg of rice is there) this equates to Rs 10 per Kg.
Now suppose one of them creates his own 1 fake note of Rs 10...now what will be the price of rice.
as now the money in the system is increased by Rs10 but...its important note that still the amount of produce i.e., nothing but rice is still 2kg, so now price the price of rice per kg would be Rs10+Rs10+Rs10(Fake currency)/2 this gives Rs 15 per kg.
this is the classic example of inflation induced by parallel economy.
And thus an ordinary person will get effected by this the most as with the rise in inflation their purchasing power though seems to increase as they have more money in hand, but actually effectively it gets reduced as the prices have overshot.
REAL INTEREST RATESNominal Interest Rates.
Real Interest Rates = (Nominal Interest Rates - Inflation)
DefinitionRate of inflation (year x) = Price level (year x) –Price level (year x-1) / Price level (year x-1)×100
Causes of Inflation
pre-1970....a) Demand Pull inflation -Either the demand increases over the same level of supply, or the supply decreases with the same level of demand. This was a Keynesian idea.
b)Cost-Push Inflation -An increase in factor input costs (i.e., wages and raw materials) pushes up prices.The Keynesian school suggested controls on prices and incomes as direct ways of checking such an inflation and, ‘moral suasions’ and measures to reduce the monopoly power of trade unions as indirect measures.
Measures to Check Inflation
(i) As a supply side measure, the government may go for import of goods which are in short-supply—as a short-term measure (as happened in India in the case of ‘onion’ and meeting the buffer stock norm of wheat).
As a long-term measure, governments go on to increase the production to matching the level of demand. Storage, transportation, distribution, hoarding are the other aspects of price management.
(ii) As a cost side measure, governments may try to cool down the price by cutting down the production cost of goods showing price rise with the help of tax breaks—cuts in the excise and custom duties (as happened in June 2003 in India in the case of crude oil and steel).
In the long-term, better production process, technological innovations etc., are helpful. Increasing income of the people is the monetary measure to avoid the heat of such inflation.
(iii) The governments may take recourse to tighter monetary policy to cool down either the demand-pull or the cost-push inflations. RBI increases the Cash Reserve Ratio,RBI increases the Bank Rate or Repo Rate in India.
In the long-run, the best way is to increase production with the help of the best production practices.
Types Of Inflation based on value
c)Hyper Inflation(The best example of hyperinflation that economists cite is of Germany after the First World War—in early 1920s)
As per the curve there is a ‘trade off’ between inflation and unemployment, i.e., an inverse relationship between them.
i.e., as inflation increases unemployment decreases.
InEarly 1970s, two American economists, Milton Friedman (Nobel Laureate, 1976) and Edmund Phelps challenged the idea of the Phillips Curve. According to them the trade-off between inflation and unemployment was only short-term, because once people came to expect higher inflation they started demanding higher wages and thus unemployment will rise back to its ‘natural rate’
non-accelerating inflation rate of unemployment (NAIRU).the NAIRU is the lowest unemployment rate that an economy can sustain without any upward pressure on inflation rate.
Stagflation is a situation in an economy when inflation and unemployment both are at higher levels, contrary to conventional belief
Reflation can also be understood from a different angle—when the economy is crossing a cycle of recession (low inflation, high unemployment, low demand, etc.) and government takes some economic policy decisions to revive the economy from recession, certain goods see sudden and temporary increase in their prices, such price rise is also known as reflation.
Skewflation is one in which there is a price rise of one or a small group of commodities over a sustained period of time, without a traditional designation.
GDP Deflator the ratio between GDP at Current Prices and GDP at Constant Prices.
If GDP at Current Prices is equal to the GDP at Constant Prices, GDP deflator will be 1.
If GDP deflator is found to be 2, it implies rise in price level by a factor of 2
if GDP deflator is found to be 4 , it implies a rise in price level by a factor of 4
Link to the Video Lecture https://www.youtube.com/watch?v=ArDXiwmGuoA&t=32s