QUESTION-Prelims-IAS –ECONOMICS MCQ-21
- Inflation is the persistent increase in the average price of commodities.
- Deficit financing and increase in budgetary taxes tend to increase the inflation, depending upon whether the deficit financing is in proportion of creating demands and supply sustainability of inflation is dependent upon it.
- Reduction in indirect taxes reduce the overall prices of products, hence, it tends to reduce the inflation. Black money is the unaccounted money on which tax has not been paid. A rise in black money reduces the government prospects of earning tax and its circulation into the market increases the inflation.
- A defective supply chain artificially manipulates the prices of goods and services (like through middlemen). This tend to increase the inflation.
- The Gross Domestic Product (GDP) deflator is a measure of general price inflation. It is calculated by dividing nominal GDP by real GDP and then multiplying by 100.
- Nominal GDP is the market value of goods and services produced in an economy, unadjusted for inflation (It is the GDP measured at current prices).
- Real GDP is nominal GDP, adjusted for inflation to reflect changes in real output (It is the GDP measured at constant prices).
- Simply put, it is the ratio of the value of goods and services an economy produces in a particular year at current prices to that at prices prevailing during any other reference (base) year.
- This ratio basically shows to what extent an increase in GDP or gross value added (GVA) in an economy has happened on account of higher prices, rather than increased output.
- There are other measures of inflation too like Consumer Price Index (CPI) and Wholesale Price Index (or WPI); however, GDP deflator is a much broader and comprehensive measure.
- Since Gross Domestic Product is an aggregate measure of production, being the sum of all final uses of goods and services (less imports), GDP deflator reflects the prices of all domestically produced goods and services in the economy whereas, other measures like CPI and WPI are based on a limited basket of goods and services, thereby not representing the entire economy (the basket of goods is changed to accommodate changes in consumption patterns, but after a considerable period of time).
- Another important distinction is that the basket of WPI (at present) has no representation of services sector.
- The GDP deflator also includes the prices of investment goods, government services and exports, and excludes the price of imports.
- Changes in consumption patterns or the introduction of new goods and services or structural transformation are automatically reflected in the deflator which is not the case with other inflation measures.
- However, WPI and CPI are available on monthly basis whereas deflator comes with a lag (yearly or quarterly, after quarterly GDP data is released). Hence, monthly change in inflation cannot be tracked using GDP deflator, limiting its usefulness.
- If GDP at current prices is equal to the GDP at constant prices, GDP deflator will be one, implying no change in price level.
- When the central bank follows Inflation Targeting, the government and the central bank together have to take steps towards ensuring price stability.
- Strong macroeconomic fundamentals like:
- Stable growth
- Low current account deficit
- Narrowing fiscal deficit
- Moderating inflation
- Low short term foreign currency liabilities and
- Sizeable exchange reserves relative to imports and liabilities are necessary for ensuring price stability.
- Repo rates and CRR are of importance to control liquidity and hence inflation. Too much money chasing too few goods will lead to inflation.
- Structural imperfections like hoarding and tax structures may also create supply side constraints leading to inflation.
- The Phillips curve is an economic concept stating that inflation and unemployment have a stable and inverse relationship. According to the Phillips curve, the lower an economy”s rate of unemployment, the more rapidly wages paid to labor increase in that economy.
- The base effect refers to the impact of the rise in price level (i.e. last year’s inflation) in the previous year over the corresponding rise in price levels in the current year (i.e., current inflation): if the price index had risen at a high rate in the corresponding period of the previous year leading to a high inflation rate, some of the potential rise is already factored in, therefore a similar absolute increase in the Price index in the current year will lead to a relatively lower inflation rates.
- On the other hand, if the inflation rate was too low in the corresponding period of the previous year, even a relatively smaller rise in the Price Index will arithmetically give a high rate of current inflation.
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