Chapter-10                       Inflation : Problems and Policies



We will define inflation is a persistent and appreciable rise in the general price level. Monetarists, in general, regard inflation as a purely monetary phenomenon. It is held that when money supply exceeds the normal absorbing capacity of the economy, it leads to persistently rising prices. In other words, when there is over-expansion of money supply and too much money chasing too few goods, inflation occurs.



Following are the indicators of inflation:

(a)      Wholesale price index

(b)      Consumer price index (used in India)

(c)      GDP deflater


When there is too much money chasing too few goods, it is the case of Demand-Pull inflation. The inflation occurs when the aggregate demand of goods and services exceeds the aggregate supply of goods and supply at the same existing price.

On the other hand Cost-Push inflation occurs when cost of production increases without increase in the corresponding productivity.


(1)      Increase in Government Expenditure: Government expenditure in India has been increasing at a very high speed since independence. The Government has to take up a number of public projects. This has resulted in the increase in demand for goods and services.

(2)      Rapid Rise in Population:India’s population has more than doubled after Independence. At present country’s population is more than 121 crores and it is almost increasing at the rate of 1.8 per cent per annum. The massive and growing size of our population has increased the demand for essential items, exerting pressure on their prices.

(3)      Urbanization: The propensity to consume in the country has increased due to increasing trend of urbanization. This has also created pressure on demand for goods and services and thereby on prices.

(4)      Role of Black Money: Private consumption has increased due to rising levels, of legal and illegal incomes. Tax evasion and violation of economic regulations have generated black money, leading to conspicuous consumption. A large part of black money is used in buying and selling of real estate extensive hoarding and black marketing in many essential wage goods, such as cereals, pulses, sugar, edible oils.

(5)      Slow Progress in Agricultural and Industrial Production: The output both in agricultural and industrial sector has increased at a very slow speed. Our agriculture still depends mainly on nature. Time and again our agriculture has been suffering from natural calamities such as droughts and floods. On the other hand, our industrial production also could not keep pace with our expectations due to lack of capital, raw materials, energy and other facilities. Thus, our production could not increase as speedily as the increase in our demand. This has created an imbalance between demand and supply which in turn gave birth to the problem of price inflation in our country.

(6)      Increase in Administered Prices: We know that there are certain goods and services whose prices are determined by the government of India. For example, prices of goods like steel, cement, coal, petroleum, fertilizer etc. and services like railways, airways, road transport etc. are also determined by the government to a large extent.

(7)      Other Factors: Prices may also rise due to increase in the cost of inputs, like in oil prices, commodity taxation, global inflation and so on.


          (i)       It creates an imbalance in the economy.

          (ii)      Untoward (unwarranted) change in the production-structure.

(iii)     Changes in the direction of resource allocation – It means we find that resources are moving from long-run projects to short-run projects and from essential professions to non-essentials professions.

(iv)     Adverse impact on the amount of real investment.

(v)      Rising prices adversely affect the economic conditions of small investors, consumers and fixed income groups, particularly wage earner. There is always a lag between price rise and money wage adjustments.

(vi)     Inflation encourages hoarding of essential commodities, leading to speculation and generation of black money.

(vii)    It aggravates the inequalities of income and wealth in the economy.

(viii)   The government also finds it difficult to complete its projects in time due to continuous price-rise.

(ix)     Danger for political and social stability.



  1. Monetary Measure: Which are adopted to control money supply or credit creation in a country are called monetary measures. Monetary Measures are adopted to release the pressures on demand for goods. In this regard Reserve Bank of India has adopted a number of credit control measures. They are given below:

(i)       Increase in bank rate

(ii)      Increase in cash-reserve ratio

(iii)     Increase in statutory liquidity ratio

(iv)     Increase in margin requirements for the commodities of short supply

(v)      Stopping of credit facilities to the hoarders

(vi)     More credit facilities to the priority sectors and reduction in credit facilities to the non-priority areas though selective credit control.

  1. Fiscal Measures:Measures related to taxation, public borrowing and public expenditure are known as fiscal measure. To control price rise government has adopted number of fiscal measures also. Prominent among them are as follows:

(i)       Reduction in public expenditure especially in the non-developmental expenditure;

(ii)      Increase in direct taxes in order to cut the purchasing power of the consumer;

(iii)     Tax concessions and subsidies to the producers to increase production;

(iv)     Withdrawal of surplus savings from the people via compulsory saving schemes and National Deposit Schemes;

(v)      Adoption of strict legal measures to control black money;

(vi)     Avoidance of deficit budgeting particularly reduction in fiscal deficit.


  1. Measures to Increase Supply:In India, agricultural prices are the kingpin of price trends and thus, they hold the key to successful price stabilization. Prices of agro-based items of mass consumption as well as some industrial raw materials exert considerable influence on the general price level.

Supply management in the industrial sector has two aspects, viz.., fuller utilization of and addition to existing capacities. This would require adequate and timely availability of power, raw materials and transport facilities.

  1. Other Measure:To control prices besides the aforesaid measure, government has adopted some other measure also such as – population immediate supply of essential hoarders, speculators and black marketers, immediate supply of essential goods to the areas having shortages, check on the monopolistic tendencies in trade etc.
  2. Price Policy: The government had taken several steps to keep the prices of essential commodities within reasonable level and also to facilitate their easy avail-ability in the open market. In view of this the maximum prices are fixed for various commodities, restrictions are imposed on the sellers to keep the prescribed maximum stock of these commodities, and they are told to exhibit price-list on their shops. The Department of Consumer Affairs monitors the prices of 12 essential commodities. Strict actions are taken by the government against hoarders, black marketers and traders indulging in unfair trade practices.




  1. Policy related to public revenue and expenditure is called _______.

          (a) Trade Policy                                   (b) Fiscal Policy

(c) Economic Policy                             (d) Monetary Policy


  1. Quantitative measure to correct inflation is _______.

          (a) Rationing of credit                         (b) Direct action

(c) Surplus Budget                              (d) Increase in Bank rate


  1. Inflation means:

(a) Price fall                                        (b) Price stagnation

(c) Price rise                                       (d) All of these


  1. Purchasing power of money falls when:

(a) Price level increases                      (b) Income level increases

(c) Price level decreases and                (d) Money supply falls


  1. Inflation, in India, is measured by:

(a) Agriculture index                           (b) Industrial price index

(c) Consumer price index                    (d) Whole sale price


  1. What is the effect of price inflation?

(a) An imbalance in the economy         (b) Danger for political stability

(c) Hoarding of essential commodities  (d) All of above


  1. Which is not a monetary measure for the control of price inflation?

          (a) Increase in bank rate                     (b) Increase in cash-reserve ratio

(c) Measureds related to taxation        (d) Credit facilities for priority sectors


  1. Cause of inflation in India is/are:

(a) Deficit financing

(b) Erratic agriculture growth

(c) Inadequate rise in industrial production

(d) All of above


  1. What was the inflation rate of India in July 2012?

(a) 6.7%                 (b) 4.7%                 (c) 6%                    (d) 3.8%


  1. When too much money chasing too few goods, the resulting inflation is called:

          (a) Deflation                                       (b) Demand-pull inflation

(c) Cost push inflation                        (d) Stagflation


  1. When price increases due to increase in cost of production, it is called:

(a) Demand-pull inflation                    (b) Deflation

(c) Cost-pull inflation                          (d) none of these


  1. The Department of Consumer Affairs monitors the prices of ____ essential commodities.

(a) 15                    (b) 12                    (c) 18                     (d) 20


  1. Which of the following is not a cause of inflation?

(a) Deficit financing                            (b) Rise in population

(c) Decrease in money supply              (d) Increase in wages


  1. Which of the following can control inflation?

(a) Deficit financing                            (b) Reduction in CRR

(c) Increase in money supply               (d) Increase in bank rate




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