Economics [2 Mark Question Answer]

Running a hyper inflation is harmful for the economy because.
(a) It reduces the purchasing power of money and hence the erosion of real income.
(b) It quickly devalues the local currency vis-a-vis other currencies in the foreign exchange market.

Inflation refers to a state of rise in the general price level.

Fixed income earners (i.e., wage and salary earners, pensioners etc.) suffer during inflation. It is because that their incomes do not increase in the same proportion in which prices or the cost of living rises. As a result, these fixed income earners tend to buy less amount of goods and services than before even when there is little rise in their income.

Consumer price index numbers measure the average change overtime in the price paid by the ultimate consumers of a specified basket of goods and services. These index numbers are also called (i) Cost of living index numbers, (ii) Retail price index numbers, and (iii) Price of living index number. The need for constructing these index numbers arise from the fact that the general price index numbers fail to give an exact idea of the effects of the change in the general price level on the cost of living of different groups of population. Such index numbers include the following goods.
(i) Food
(ii) Clothing
(iii) Fuel and lighting
(iv) Housing
(v) Education
(vi) Miscellaneous

Food basket (also called farmer's basket) consists of specified food items of daily individual consumption. The average price is taken as a measure of food inflation.
A constant rise in the price level of all agricultural food item is called food inflation.

Farmers generally gain during the periods of inflation because they get better prices for their crops.
However, small farmers do not gain much during inflation as a major part of their production is kept for self consumption. But they have to purchase inputs (e.g. seeds, fertilizers etc.) at high prices.

When prices rises due to rise in cost of production, it is called cost push inflation.
Two factors causing cost push Inflation
(i) Cost push inflation may be caused due to an increase in wage cost.
(ii) Increase in price of basic raw-materials causes cost push inflation.

When prices rises due to rise in cost of production, it is called cost push inflation.

A mild inflation or creeping inflation is beneficial for economic growth. Increasing prices of goods and services generally lead to increase in the profit margin. This induces the producers to undertake more investment. As a result, the level of output and employment increases in the economy. In this way, mild inflation is regarded essential for economic growth.

Fixed income earners (i.e., wage and salary earners, pensioners etc.) suffer during inflation. It is because that their incomes do not increase in the same proportion in which prices or the cost of living rises. As a result, these fixed income earners tend to buy less amount of goods and services than before even when there is little rise in their income.

Demand pull inflation refers to a situation in which prices rise because the demand for goods and services exceeds their total available supply at current prices. It is also caused by increase in money supply.

Two factors causing cost push Inflation
(i) Cost push inflation may be caused due to an increase in wage cost.
(ii) Increase in price of basic raw-materials causes cost push inflation.

(i) Farmers obtain better prices for their crops.
(ii) Government raises more tax revenues as monetary income of people increases.

Inflation has a mixed effect on the investors. Investors in fixed interest earning assets (like bonds, debentures and deposits) are the losers, whereas investors in shares of the companies tend to gain during inflation. Small investors who invest their money in bonds, debentures and deposits with the commercial banks tend to lose because they receive only a fixed interest income from such investment. On the other hand, investors in shares tend to benefit because they get more dividend on account of high profits made by joint stock companies during inflation.

Running a hyper inflation is harmful for the economy because.
(a) It reduces the purchasing power of money and hence the erosion of real income.
(b) It quickly devalues the local currency vis-a-vis other currencies in the foreign exchange market.

→ The producers gain during inflation in the short period. Usually, the cost of production does not rise as fast as the price of their products. So there emerges an artificial margin of profit.
→ As against this, inflation affects the producers adversely in the long run. If the price level goes on increasing, the total consumption (or demand) would fall. This reduced demand will ultimately reduce their profit.

A mild inflation or creeping inflation is beneficial for economic growth. Increasing prices of goods and services generally lead to increase in the profit margin. This induces the producers to undertake more investment. As a result, the level of output and employment increases in the economy. In this way, mild inflation is regarded essential for economic growth.

Farmers generally gain during the periods of inflation because they get better prices for their crops.
However, small farmers do not gain much during inflation as a major part of their production is kept for self consumption. But they have to purchase inputs (e.g. seeds, fertilizers etc.) at high prices.

By value of money we mean the purchasing power or buying capacity of money. It refers to the amount of things which can be exchanged for a unit of money. The value of money depends upon the prices of goods and services. During the time of inflation, prices of goods and services increase. Therefore, purchasing power of money falls. There exists inverse relationship between price level and value of money.

(i) Increase in money supply.
(ii) Increase in demand for goods and services.