Page 172 - DECO201_MACRO_ECONOMICS_ENGLISH

Unit 10: Theories of Inflation

10.1 Meaning of Inflation Notes

Inflation is understood by most people as a substantial rapid general increase in the level of
prices and consequent devaluation in the value of money over a period of time. Harry Johnson,
for instance, defines inflation as “a sustained rise in price”. Crowther similarly defines inflation
as “a state in which the value of money is falling, i.e., the prices are rising”. The common feature
of inflation is price rise, the degree of which may be measured by price indices. Edward Shapiro,
thus, puts that “recognising the ambiguities that our words contain, we will define inflation
simply as a persistent and an appreciable rise in the general level of prices”.
Thus, inflation is statistically measured in terms of the percentage increase in the price index as
a rate per cent per unit of time – usually an year or a month.

!
Caution While inflation means a rise in the general price level, the rate of inflation is the
rate of change of the general price level. It is measured by a simple formula as follows:

Rate of inflation

Where, P is the price level in year t, P - 1 is the price level in year t-1, the base year. If there
t t
is a decline in the rate of inflation, such a situation is called DISINFLATION.

Did u know? The most recent period of disinflation in India occurred in India since the
middle of 1991 when the high rate of nflation which had crossed double digit levels and
was around 17 per cent, was brought down to around 7 per cent, thanks to a package of
Macro Economic stabilisation policies introduced by the government.

Types of Inflation

Open Inflation: In a free market economy, prices go up freely due to supply-demand imbalances
leading to open inflation.
Suppressed Inflation: Suppressed inflation occurs in a controlled economy where the upward
pressure on prices is not allowed to influence the quoted or managed prices. But inflation
reveals itself in other forms.

Example: Government may introduce rationing of goods leading to long queues in
front of ration shops. There is very likely to be a black market for such goods whose prices are
far above the quoted prices. In India, suppressed inflation manifests itself in the prices of essential
goods sold through PDS. The ration prices are deliberately maintained at a certain level while
the open market prices are above this level.
Creeping Inflation, Galloping Inflation and Hyper Inflation

These three categories of inflation are recognised on the basis of severity of inflation, as measured
in terms of rate of rise in prices.
There is moderate rise in prices of 2-3 per cent per annum in creeping inflation. It is generally
considered good for a growing economy. Mildly rising prices result in faster growth of output

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