What Do You Understand About ‘Inflation’ – Part 2

Hi, hope you enjoyed the introductory blog on inflation… lets delve into a few more definitions that are very apt and relevant for a developing economy like India.

Consumers like you and I face true inflation in the retail market. Since the past more than six months the price of pulses skyrocketed in India and the country had to import pulses, especially Tur or Tuvar dal (Arahar). A couple of weeks ago the price of beans (vegetable) shot up to Rs.150 – Rs.170 a kg. and that of tomatoes to Rs.70 – 80 a Kg. Today’s youngsters know and understand ‘surge’ price charged by Taxi & Airline companies. These illustrations bring out the supply side, in relation to demand, of the definition of inflation. Any bottleneck, temporary or permanent, in the supply of goods would lead to increase in their prices.

Increase in prices of commodities caused by a temporary supply side bottleneck, like the recent floods in Chennai, or let’s say lorry owners going on strike thereby affecting movement of goods, cannot strictly be termed as inflation. However, the area of cultivation of pulses getting reduced in India in relation to the growth of population is a permanent supply side constraint. This results in demand exceeding supply, leading to increase in the price of pulses. This would be termed as inflation because it would be persistent and a medium to long term solution is warranted.

A number of structural changes are taking place in the economy which impact the price levels of goods and services. For example, the exponential growth in the services sector especially the IT and financial sectors have enhanced the disposable income in the hands of its employees, resulting in spending sprees and contributing to the increased price levels. The contribution of services sector in the GDP of India is around 55%.

Another structural change worth mentioning is the change in the consumption pattern of the population of the emerging market economies. The demographic change happening in India is an important factor for increase in the demand for protein food. A case in point is the increase in the prices of pulses, Milk and sea food etc. in India.

In India, social welfare measures such as MNREGA (Mahatma Gandhi Rural Employment Guarantee Act), Direct Bank Transfers of the subsidy have enhanced the disposable income in the hands of rural population. This is another important factor for the change in the consumption pattern and increase in the prices of essential articles.

In the Emerging Market Economies, especially in countries like India, China, Thailand, Brazil… to name a few… price levels are also impacted by what we term as ‘Externalities’.

I fondly remember my Professor of Economics who some 40 years ago used to say that if the president of America sneezes in America, the price of Ladies Finger in Aminjikarai (a locality in Chennai where he lived) would go up. Nothing succinctly captures the principle of externality than this analogy. What is the connection?…

When we meet next we will look at these connections…

See you. Take care