Solutions to Assignments
MBA and MBA (Banking & Finance)
MMPC 03 - Business Environment
MMPC-003/TMA/JULY/2022
Question No. 1. Define inflation. What are the different methods of measuring inflation and what are the effects of inflation.
One of the most daunting task before economists is to define Inflation as there are multitudes
of problems in penning down one definition. Therefore there is no universal definition for
this problem. Many economists have given different definition like according to Coulborn,
Inflation can be understood as a situation whereby “too much money chases too few goods”.
A situation in which the value of money falls and price rises is inflation according to
Crowther. These and other definitions have one or another deficiency.
Economists are unanimous that inflation refers to a ‘persistent’ and ‘appreciable’ rise in the
general price level. However, the word persistent and appreciable are not clearly defined so
there is space for ambiguity. For example, whether the rate of price rise by 1 %, 5 % or 30 %
is considerable or there is some other rate which is deemed to be considerable.
The issue of inflation is of utmost importance because it is both boon as well as bane. A rise
in prices is necessary for producers to induce them to supply more in the market. But higher
prices lead to more burden on the consumer pocket and it may also create many political and
social problems. So, what an economy needs is a moderate rate of inflation. This takes us to
another question, what is a moderate rate of inflation? The answer to this question varies
from country to country depending on the level of development. For instance, in the case of
India, a committee set up by the Reserve Bank of India (RBI) to review the monetary system
which is popularly known as Chakravarty Committee (1985) recommended that 4 percent
rate of Inflation is desirable for India’s economic growth.
Different Methods of Measuring Inflation
There are two common methods of measuring inflation.
Inflation affects almost all the economic agents of the economy be it consumer, producer or
government. The favourable or unfavourable effect depends upon the rate of inflation. In this
section, you will understand how does it impact the distribution of income and wealth,
producers, wage earners, borrowers and lenders and some other segments of the economy.
Impact on Income Distribution
How will inflation affect income and wealth distribution depends upon the prices of the
output which the producer produces and the prices of the inputs like labour and land. If
output prices rise more than input prices, then income will be distributed in the favour of the
producer or the profit earner or the employer. The plausible explanation is when the price of
output rises, it translates to higher revenue and profit of the producer. So the revenue-wage
gap increases and the larger share of the national income goes to the employer. The overall
impact is that firm/producer who was already rich they get even richer and the poor
(especially labour) get poorer.
Deterioration in the Value of Money
Inflation erodes the purchasing power of money. It implies that the real wages or real income
decline with a rise in prices. For example, let us suppose that the price of good X was Rs 10
per piece and you have Rs 500 as your money income. So if you spend your entire income on
good X, you could buy 50 units/pieces. Now keeping other things constant the price of good
X rise to Rs 20 per piece. Now the same Rs 500 can fetch you only 25 units of X good. So the
currency denomination remains the same but its purchasing power reduces. You can buy
fewer goods with the same income. This type of effect is most harmful to daily wage earners, persons with fixed income and employees working in the unorganised sector, as they do not
have any safeguard against this price rise.
Impact on Borrowers and Lenders
It is the borrowers who tend to gain due to inflation and lenders lose. Now suppose you are a
borrower and you borrow money at the prevailing rate of inflation. Now when you repay the
same amount to your lender no doubt you are paying the same amount with the rate of
interest but the real value of money has reduced. More specifically you pay less in terms of
purchasing power or goods and services. So you(borrower) gain and your lender losses.
Methods of Taming Inflation
Monetary policy is one of the policy option and direct method of controlling inflation.
Reserve Bank of India makes use of monetary policy to regulate the supply of credit in the
market.
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