This document discusses various topics related to inflation including: - Definitions of inflation and general price levels - Types of inflation such as anticipated, unanticipated, walking, and galloping inflation - Parties affected by inflation such as families receiving subsidies, investors, and debtors - Causes of inflation including demand-pull and cost-push inflation - Policies to reduce inflation such as monetary and fiscal policies - Methods of calculating and measuring inflation including price indices, absolute prices, and comparative prices

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Price levels
Unit 06

2. RASHAIN PERERA
rashainperera@gmail.com
077 059 37 52
Prepared by
2

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What is inflation?
 The continuous rise in the general
price levels in the economy over a
period of time could be simply
termed as “inflation”.
 Inflation is defined as a sustained
increase in the general level of
prices for goods and services.

4. General price levels
 The general price level is a
hypothetical daily measure of overall
prices for some set of goods and
services (the consumer basket), in
an economy or monetary union during
a given interval (generally one day)
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Anticipated inflation
 In this case people anticipate or
forecast that future prices would
rise or go up resulting inflation hence
necessary precautionary steps or
actions are taken at present.
 However, all these precautionary
measures would be temporary
solutions for inflation
 These temporary solutions are
termed as “indexation”

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Indexation
 This is a temporary solution taken by
people in situations of inflation
 Here people try to influence for the
changes in real variables such as
taxation, wages, interest rates etc
in order to net off negative effects
of inflation

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Unanticipated inflation
 Inflation that arise due to temporal
factors.
 E.g. change of government, Instant
natural destructions, war, recession

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 Moderate-inflation less than 10%
 Double digit inflation-10%-99%
 Hyper inflation/3 digit inflation-inflation
more than 100%
 Creeping/mild inflation- a small rise over a long
period of time
 Stagflation- very high inflation, unemployment,
negative growth
 Suppressed inflation- inflation that is
controlled by the government
Types of inflation

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 Core inflation- inflation rate calculated
excluding food and energy items from NCCPI
 Structural inflation- inflation built into an
economy due to the governments monetary
policy
 Deflation- decrease in GPL over a period of
time
 Disinflation- is the slow down of the inflation
rate being a positive figure
Types of inflation

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 Walking inflation- This type of strong, or
pernicious, inflation is between 3-10% a year.
It is harmful to the economy because it
heats up economic growth too fast. People
start to buy more than they need, just to
avoid tomorrow's much higher prices. This
drives demand even further, so that suppliers
can't keep up.
Types of inflation

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 Galloping inflation- When inflation rises to
ten percent or greater, it wreaks absolute
havoc on the economy. Money loses value so
fast that business and employee income can't
keep up with costs and prices. Foreign
investors avoid the country, depriving it of
needed capital. The economy becomes
unstable, and government leaders lose
credibility.
Types of inflation

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 A family who is receiving a subsidy in
kind- positively
 A family who is receiving a subsidy in
monetary terms- negatively
 An investor- positively
 An interest owner from a bank
deposit- negatively
 Debtor- positively
 Creditor- negatively
Parties affected by inflation

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 Importer- positively
 Exporter- negatively
 Savings- negatively
 Investments- negatively
 Fixed income earners- negatively
 Variable income earners- positively
Parties affected by inflation

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 Shoe-leather costs
 Menu costs
 Confusion costs
 Psychological costs/political costs
 Unemployment or negative growth
 Foreign investments being less
attractive
 Fall of exports
 High income disparity
Costs of inflation

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 Demand pull inflation
 Cost push inflation
Causes of inflation

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Demand pull inflation
 Aggregate demand is a composition
of:
 Consumption
 Investment
 Government purchases
 Net exports

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 Demand pull inflation is caused when
these factors change so that
aggregate demand increase
 i.e
 Consumption increase
 Investment increase
 Government exp increases
 Exports increase
 Imports decrease

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AD
AS
Eq. price
New Eq. price

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Cost push inflation
 This happens when cost of
production increase
 The increase in cost pull the supply
curve upward or backward

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AD
AS
Eq. price
New Eq. price

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Policies implemented
to reduce inflation.

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 Monetary policy- increase in interest
rates
Savings increase, investment decrease,
consumption decrease
 Fiscal policy- decrease government
expenditure, increase taxes
Consumption decrease, government
expenditure decrease
 Supply side policies
Producers are given subsidies, costs of
production reduces

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 Price indices are used to calculate
price levels or inflation
 It is important to study on absolute
prices and comparative prices in this
context
Calculating or measuring
inflation

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Absolute prices
 Changes in prices of an individual
product
 This helps to measure inflation

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Comparative prices
 Comparing the changes in price of a
commodity to another commodity
 This helps to identify the resource
allocation

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Price index
 What is a price index?
 Average prices of a basket of selected
goods and services in a present period
of time compared with a price of a
base year could be simply termed as a
price index

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Various price indices
 GDP deflator
 Wholesale price index
 Colombo Consumers Price Index

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GDP deflator or implicit
price index
 (Nominal GDP/real GDP) x 100
 (constant price GDP/current price
GDP) x 100

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Wholesale price index
 This is prepared by CBSL to measure
changes in prices at the primary
sales level

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Colombo consumers price
index
Basis CCPI(N)
Base year
Coverage
Target household units
Size of household unit
Total number of items
Price collection centers
2006/07=100
All urban divisions in Colombo
district
All households in Colombo district
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373
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32. RASHAIN PERERA
rashainperera@gmail.com
077 059 37 52
Prepared by
32