7.2 ndian onom
Section-A
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.