In common parlance inflation is often defined as a state of rising prices. It is indicated by increases in the index number of prices over time.
It is a state of disequilibrium in the economy. But sometimes an inflationary situation does not exhibit increases in the price index, if price control and rationing are practiced by the government.
Then conditions for the price rise exist in the economy, but through administrative devices prices are not allowed to rise.
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In order to distinguish between the two situations when prices rise continuously in the market through the forces of demand and supply and when the forces of demand and supply are suppressed with the help of extra market forces of government control—we use the terms ‘open inflation’ and ‘suppressed inflation’.
In an open inflation the condition of disequilibrium is directly expressed through the rise in the price level, while it is counteracted by the extra- market force of control. But if controls are withdrawn, prices begin to rise and inflation becomes open.
Inflation is generally used to mean a rise in the general level of prices. However, all price rises may not be inflationary. For example, food grains may be dearer due to crop failure but other prices may remain steady.
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That is why Martin Bronfen brenner defined inflation as a rise in price levels with a number of additional characteristics, namely (1) it does not increase real output and employment, (2) it leads (through cost changes) to further price movements, (3) it is faster than some ‘safe’ rate, (4) it arises from the side of money, (5) it is measured by prices net of commodity taxes and subsidies, and (6) it has been imperfectly anticipated.
We can add three more characteristics of inflation: inflation per se is a process. It is associated not merely with high prices but also with rising prices. Thus it is not a static condition but a movement—a kind of imbalance.
It is a dynamic process which has to be observed over some length of time; (b) the price rise is pervasive. It is not a specific group of commodities but all commodities in general as well as services become costlier; and (c) there is an element of artificiality in inflation.
It originates from some deliberate action on the part of the government, the central bank, the business or trade unions. In other words, it is not natural but manmade.
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The traditional explanation of inflation runs in terms of changes in the money supply. While helpful in explaining inflation these concepts are theoretically inconclusive and practically inadequate.
The quantity theory type of explanation has been greatly improved by the income-expenditure approach to inflation as developed by Keynes.
By relating expected expenditure to disposable income in relation to the value of available output at base prices Keynes originated the concept of inflationary gap. The inflationary gap shows the process by which inflation starts.
The inflationary gap for the economy as a whole may be defined as an excess of anticipated expenditure over available output at base prices.
Anticipated expenditure is given by consumption-saving patterns plus the tax structure, while available output is given by conditions of employment plus technological structure.
The problem is one of keeping expenditures down to the level of current output instead of letting those expenditures bid up the value of that output.
According to Keynes pure inflation or true inflation can be had after full employment has been attained. At full employment a further increase in effective demand spends itself in raising the general level instead of enlarging aggregate output and employment. But semi-inflation is likely to develop with increased money supply before the point of full employment is reached.
Pigou has distinguished two types of inflation—wage induced and deficit induced. Inflation is said to be wage induced if there is a general rise in prices on account of an increase in the money cost of production.
Increase of money wages increases cost of production without increasing output and causes prices to raise still further. Inflation is said to be deficit-induced type, if the rise in prices is directly due to deficit financing of a part of the public expenditure.