What is money
Money is anything which performs the following functions
- Medium of exchange
- A measure of value
- A store of value over time
- Standard for deferred payment
Measure of money supply
- Narrow money(M1) = Currency with public + Demand deposits with banking system + Other deposits with the RBI
- M2 = M1 + Savings deposits of post office saving banks
- M3 = M1 + Time deposits with banking system
- M4 = M3 + All deposits with post office saving banks(excluding National Saving Certificates)
Inflation
Inflation refers to regular increase in the general price level of prices of goods and services, in an economy, over a period of time. Inflation leads to fall in purchasing power,’ because with rise in price of goods and services, the same amount of money, can purchase fewer goods and services.
Causes of Inflation
- Demand-Pull Inflation: It is rise in general prices caused by increasing aggregate demand for good and services. Increasing quantity of money in the hands of the people increases the aggregate demand for goods and services, and if aggregate supply does not follow the suit, prices rise.
- Cost -Push Inflation: It is a type of inflation caused by substantial increases in the cost of production of important goods or services where no suitable alternative is available. For example, if prices of some key inputs like oil rise, producers will have to either adjust output supply or translate the higher costs into higher output prices. When output declines because of cost pressure on producers, there will be a shortage in output markets and as a result prices will rise.
Measures of Inflation
Inflation denotes a rise in the general level of prices. The general price level is measured by a price index. A price index is a weighted average of the prices of a selected basket of goods and services relative to their prices in some designated base-year.
Calculating Inflation with Price Indexes
Inflation is calculated by taking the price index of the year for which inflation is being measured and subtracting the base year from it, then dividing by the base year. This is then multiplied by 100 to give the percentage(%) change in inflation.
Inflation = (Price Index in Current Year — Price Index in Base Year)/ Price Index in Base Year*100
- Ex- Nov-2018 price index is X and Nov-2017 price index was Y
Inflation = (X-Y) * 100 / Y
= ___ %
The most important price indexes are
- Wholesale Price Index (WPI): The WPI reflects the change in the level of prices of a basket of goods at the wholesale level. WPI focuses on the price of goods traded between corporations at the wholesale stage, rather than goods bought by consumers. WPI helps to monitor price movements that reflect supply and demand in industry, manufacturing and construction sectors. It is called Headline inflation.
- Consumer Price Index (CPI) The CPI reflects the change in the level of prices of a basket of goods and services purchased/consumed by the households. It measures the prices at the retail level. This is the measure of inflation more relevant for the consumers. It is the cost of living index popularly known as Core Inflation. There are four different index numbers of consumer prices. These are: (i) CPI for industrial workers (CPI-1W) (ii) CPI for agricultural labourers (CPI-AL) (iii) CPI for rural workers (CPI-RW) and (iv) CPI for urban non-manual employees (CPI-UNME). CP! in India is released by Labour Bureau, Ministry of Labour and Employment, Government of India.
- GDP Deflator GDP deflator is a measure of the level of prices of all new, domestically produced, final goods and services in an economy. The GDP deflator is not based on a fixed basket of goods and services. The basket is allowed to change with people’s consumption and investment patterns.