7.2          ndian       onom
                                                                            When the general level of prices is falling
         IntroductIon                                                 over a period of time this is deflation, the
     For a layman, inflation is just price rise. It becomes           opposite situation of inflation. It is also known
     a matter of everyday discussion if the prices                    as disinflation. But in contemporary economics,
     of daily or weekly items start rising. Whatever                  deflation or disinflation not used to indicate fall
     impact it might be having on other areas of                      in prices. Instead, a price rise is termed a ‘rise
     economy, inflation might take an ugly turn and                   in inflation’ and a price fall is termed a ‘fall in
     lead to a political crisis—at least in the developing            inflation’. The terms deflation or disinflation
     economies. India has seen governments thrown                     have become part of the macroeconomic policy
     out of power in elections due to price rise in daily-            of modern governments. In policy terms,
     use items. This is not the case in the developed                 deflation or disinflation means a reduction in
     economies, but inflation takes its political toll                the level of national income and output, usually
     there, too. In the developed economies, more                     accompanied by a fall in the general price level.
     aware and informed voters get carried away by                    Such a policy is often deliberately brought about
     the greater impact of higher or lower inflations                 by the governments with the objective of reducing
     in the elections. In this chapter, we will try to                inflation and improving the balance of payments
     examine the concept of inflation from all possible               (BoP) by reducing import demand. As instruments
     dimensions to have an overall understanding.
                                                                      of deflation, the policy includes fiscal measures (as
                                                                      for example, tax increase) or monetary measures
         defInItIon                                                   (as for example, increase in interest rate).
     A rise in the general level of prices;1 a sustained                    The rate of inflation is measured on the basis of
     rise in the general level of prices;2 persistent                 price indices which are of two kinds—Wholesale
     increases in the general level of prices;3 an increase           Price Index (WPI) and Consumer Price Index
     in the general level of prices in an economy that                (CPI). A price index is a measure of the average
     is sustained over time;4 rising prices across the                level of prices, which means that it does not show
     board5—is inflation. These are some of the most                  the exact price rise or fall of a single good. The rate
     common academic definitions of inflation. If the                 of inflation is the rate of change of general price
     price of one good has gone up, it is not inflation;              level which is measured as follows:
     it is inflation only if the prices of most goods have                  Rate of inflation (year x) = Price level (year x)
     gone up.6                                                        –Price level (year x-1) / Price level (year x-1)×100
         1.  Samuelson, Paul A. and Nardhaus, William D.,                   This rate shows up in percentage form (%),
             Economics, Tata McGraw-Hill, N. Delhi, 2006, p. 439.     though inflation is also shown in numbers, i.e.,
         2.  Mc Cormick, B.J. et.al, Introducing Economics, Penguin
             Education, Great Britain, 1974, p.609.
                                                                      digits. A price index is a weighted average of
         3.  Penguin Dictionary of Economics, Penguin Books,          the prices of a number of goods and services.
             London, 7th Ed., 2003.                                   In the index the total weight is taken as 100 at
         4.  Collins internet-linked Dictionary of Economics, Harper- a particular year of the past (the base year), this
             Collins Publishers., Glasgow, 2006.
                                                                      when compared to the current year shows a rise or
         5.  Mathew Bishop, Pocket Economist, The Economist,
             London, 2007, p. 121.                                    fall in the prices of current year, there is a rise or
         6.  Stiglitz, Joseph E. and Walsh, Carl E., Economics, W.W.  fall in the ‘100’ in comparison to the base year—
             Norton & Company, New York, 2005, p. 509.                and this inflation is measured in digits.