Inflation and Business Cycle
Inflation and Business Cycle
Inflation
Inflation refers to a sustained rise in the general price level of goods and services in an economy over a period of time. It reduces the purchasing power of money, meaning each unit of currency buys fewer goods and services.
Types of Inflation
1. Demand-Pull Inflation
Caused by excessive demand in the economy relative to supply.
Example:
During festive seasons, demand for electronics surges, leading to price increases.
2. Cost-Push Inflation
Caused by rising production costs (wages, raw materials, energy prices), which are passed on to consumers.
Example:
A rise in crude oil prices increases transportation costs, leading to higher prices of goods.
3. Built-In Inflation
Caused by wage-price spiral – workers demand higher wages, businesses raise prices to compensate.
Other Variants
- Stagflation: Combination of high inflation and stagnant economic growth.
- Hyperinflation: Extremely rapid, uncontrolled rise in prices.
- Disinflation: Slowing rate of inflation (prices rise but at a slower pace).
- Deflation: General decline in prices, often linked to economic contraction.
Causes of Inflation
- Excessive money supply (monetary factors).
- Supply chain disruptions (like during COVID-19).
- International price shocks (like crude oil price hikes).
- Higher wages and production costs.
Measuring Inflation in India
- Consumer Price Index (CPI) – Measures retail inflation (basis for monetary policy).
- Wholesale Price Index (WPI) – Measures inflation at wholesale level (used for tracking prices of goods traded between businesses).
Impacts of Inflation
- Erodes purchasing power.
- Hurts fixed income earners.
- Can benefit borrowers (debt devalues).
- Reduces savings if interest rates are lower than inflation.
Business Cycle
The business cycle refers to the fluctuations in economic activity over time, consisting of periods of expansion and contraction.
Phases of Business Cycle
1. Expansion (Boom)
- Rising GDP, employment, and demand.
- Businesses invest and expand.
- Optimism dominates.
2. Peak
- Economy reaches maximum output.
- Shortages and overheating may occur.
- Inflation often rises.
3. Recession
- Declining GDP, falling demand and investment.
- Unemployment increases.
- Consumer and business confidence falls.
4. Trough
- Economy hits rock bottom.
- Low economic activity, low inflation, and high unemployment.
- Paves the way for recovery.
Causes of Business Cycles
- Changes in investment levels.
- Monetary policy (interest rate changes).
- External shocks (wars, pandemics, oil price spikes).
- Technological innovations and disruptions.
Statement-based MCQs
MCQ 1
Consider the following statements regarding inflation:
- Inflation always benefits borrowers.
- Cost-push inflation can occur even if demand remains constant.
- The Consumer Price Index (CPI) is used by the Reserve Bank of India to frame monetary policy.
Which of the statements given above is/are correct?
a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3
MCQ 2
Which of the following conditions characterises Stagflation?
- Rising inflation
- High unemployment
- Rapid economic growth
Select the correct answer using the code below:
a) 1 and 2 only
b) 2 and 3 only
c) 1 and 3 only
d) 1, 2 and 3
MCQ 3
Which of the following is the most accurate measure of inflation faced by consumers in India?
a) Wholesale Price Index (WPI)
b) Consumer Price Index (CPI)
c) Index of Industrial Production (IIP)
d) GDP Deflator
MCQ 4
During which phase of the business cycle is unemployment typically at its highest?
a) Expansion
b) Peak
c) Recession
d) Trough
MCQ 5
Which of the following are typically associated with a recession?
- Declining GDP
- Falling investment
- Rising inflation
Select the correct answer using the code below:
a) 1 and 2 only
b) 2 and 3 only
c) 1, 2 and 3
d) 1 only
