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Types of inflation

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Types of inflation

  1. 1. On the basis of causes 1. Demand pull inflation 2. Cost push inflation
  2. 2. Demand pull Inflation: If the demand for goods and services excessive over limited supply, then demand pull inflation occurs. Main causes of demand pull inflation are as follows: a. Increase in money supply & bank credit b. Increase in public expenditure in productive purpose. c. Reduction in taxes. d. Increase in private expenditure. e. Repayments of public debts. f. Increase in foreign demand for domestic goods. g. Increase in population. h. Money earned by illegal activities.
  3. 3. Demand Pull Inflation As E4 E3 E2 E1 AD4 AD3 AD2 AD1 Q1 Q2 Q3 Y P4 P3 P2 P1 O X Price level Output level
  4. 4. Cost push Inflation: If aggregate demand exceeds over aggregate supply due to cost raising factors such as increase in profit margin and wage cost, supply shock etc. it is said to be cost push inflation. Main causes of cost push inflation are as follows: a. Increase in wage rate. b. Increase in indirect taxes. c. Increase in profit margin (profit push inflation). d. Reduction of subsidies. e. Increase in interest rate. f. Supply shock. g. Devaluation of currency.
  5. 5. Cost Push Inflation E1 E2 P2 P1 Q2 Q1 AD As Y X Price level Output level
  6. 6. Measures of rate of inflation  The inflation rate between two periods of time is measured by the percentage increase in the relevant price index from the first period to the second period.  Let 푃푡−1 indicates the value of the price index in the first period and 푃푡 is the value in the second period, then the inflation rate can be measured as: Rate of inflation (r) = 푃푡 − 푃푡−1 푃푡−1 × 100
  7. 7. Consumer price index (CPI):  CPI measures the change in the general level of price and they fail to reflect the effects of the increase or decrease of price on the cost of living of different class or group of people in a society. The CPI can be computed in following two ways: 1. Aggregate expenditure method / Weighted aggregate method: 2. Family budget method / Method of weighted relative:
  8. 8. 1. Aggregate expenditure method / Weighted aggregate method: It can be calculated as CPI = 푝1푞0 푝0푞0 × 100 where, 0 = Base year 1 = current year
  9. 9. 2. Family budget method / Method of weighted relative: It can be calculated as CPI = 푝1푞0 푝0푞0
  10. 10.  The GDP deflator measures the relative change in the current level of price in comparison to the level of price in the base year.  In other words, the GDP tells us the increase in nominal GDP i.e. attributable to as increase price rather than an increase in quantity produced. GDP Deflator can be calculated as GDP Deflator = 푁표푚푖푛푎푙 퐺퐷푃 푅푒푎푙 퐺퐷푃 × 100 GDP Deflator: