For better understanding, Inflation is termed as a general increase in price and decrease in purchasing value of money. Inflation occurs due to imbalance between the demand and supply of the money, changes in the production and the distribution cost and the increase of taxes on products.
Inflation occurs in the society when there is expansion of the total amount of money.
For instance: the price of an apple is one gold coin today but tomorrow X won a lottery and purchased 10 apple because he had more gold coins, the money supply in economy has just expanded as it has experienced inflation, then the fruit seller has more gold coins and he can use it to purchase other commodities from other shopkeepers, so now shopkeeper need to purchase apples but the fruit seller had sold most of the apples to X as X had more gold coins, this signifies that now he has less apples and he realised that he can increase the price of the apples from one gold coin to two gold coins for an apple as in the market money flow was increasing and there are demand for apples in the market.
The above example proves that once a new money enters the economy the prices rise and the purchasing power of money decreases. It will benefit only those who had taken the new money first.
Inflation works when both the factors work together which are demand and supply as when demand for goods and services in an economy exceeds supply of the same (Goods and Services) inflation ascends.
Now the question arises what causes increase in demand? There are multiple factors which causes increase in demand which are:-
- Increase in public expenditure.
- Increase in private expenditure (increase in factors of production and commodities).
- Increase in consumer spending.
- Reduction in taxation.
- Repayment of past internal debts.
- Increase in population.
- Increase in exports (Goods shortage in the domestic country).
- Deficit financing.
Imbalance in demand and supply can also be caused by decrease in supply, some factors which causes decrease in supply are:-
- Shortage of factors of production.
- Industrial disputes.
- Natural calamities.
Sometime inflation reaches the maximum level and it is called hyperinflation. Hyperinflation is a situation where the Government welfare schemes exceed logical expenditure and the prices reach the maximum value and money eventually becomes worthless.
The effect of inflation on economic performance is an important and complex topic but it is important, because if systematic inflation has real effects, governments can influence economic performance through monetary policy. There is little theoretical approach on how inflation affects economic performance and for that a negative influence of inflation on growth is also essential. Yet many economic theories predict neutrality or even a positive effect of average inflation on economic performance. Apart from the effect of trend inflation, inflation uncertainty may also influence output growth. As in the case of average inflation, the effect of uncertainty on growth can either be positive or negative. A further complicating factor is that there may be a relationship between average inflation and the degree of uncertainty about future inflation. That is, it has been argued that higher inflation is less predictable. A well-constructed empirical test for the real effects of inflation has the potential correlation between these two factors.
Some simple negative effects of inflation are:-
- Consumer will suffer a loss in their purchasing power and real income unless the consumer incomes are increased at the same rate of inflation, the cost of living will rise, reducing the standard of living for consumers.
- Producers and businesses will be forced to increase their prices, reacting to the higher costs and excess demand. Businesses may also reduce their work force to cut labour costs, which may lead to increased rate of unemployment.
- Exporters and Importers may suffer a temporary or permanent loss of international competition as it may be difficult to pass on higher production costs in the form of increased prices.
Some positive effects of inflation are:-
- Moderate inflation enables adjustment of wages as it is argued that a moderate rate of inflation makes it easier to adjust wages. For example, it may be difficult to cut nominal wages. But, if average wages are rising due to moderate inflation, it is easier to increase the wages of productive workers whereas unproductive workers can have their wages fixed which is effectively a real wage cut. If we had zero inflation, we could end up with morereal wage unemployment, with firms unable to cut wages to attract workers.
- Inflation can boost growth, At times of very low inflation the economy may be stuck in a recession. Arguably targeting a higher rate of inflation can enable a boost in economic growth. This view is controversial as not all economists would support targeting a higher inflation rate. However, some would target higher inflation, if the economy was stuck in a prolonged recession.
But whatever the precise level are, most do agree that a little dose of inflation is absolutely essential be it positive or negative.
The conclusion would be as quoted by the Austrian philosopher and economist Ludwig von Mises. "The most important thing to remember is that inflation is not an act of God, that inflation is not a catastrophe of the elements or a disease that comes like the plague”, looking at the quote it is quite evident that inflation play an important role in economy as it can be controlled beforehand but now as an element of economy it really helps the country to know where it stands in the international market and whether they have necessary action plans to control inflation when the economy is not in a good shape. For better functioning of an economy the society must maintain a proper balance of demand and supply but should keep in mind that lack of inflation (deflation) is not necessarily something to be proud off as it decreases the general level of price and creates unemployment. The advent of the monetary policy committee and the widened scrutiny of India’s inflation percentage will hopefully address this possible economic malaise.
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