Economics/inflation

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Question
Sir,
In both America and India governments often declare inflation levels of  2 to 3 percent often after a slight price drop in petroleum products. Then politicians brag about new consumer price index, purchasing power and living standard levels.
Meanwhile, an average family  shopping finds their retail bill   went up by 10 to 20 percent. I had bitter experience in movie, bus tickets, taxi fare, soap, tooth paste, pens, hotel fare etc.
Possibly, only exceptions are consumer electronics hardware, cell phones and PC. It seems to me.
Why these contradictory inflation statistics? Or government agencies use outdated methods?
Please explain,
Jose, India.

Answer
Hi Jose,

Sorry for writing a late reply: I was a bit too busy.

As you say, why are there divergent prices in different countries, and divergent prices for different commodities in the same country incommensurate with the inflation rate? Your concern is understandable. However, there is a deeper meaning to inflation than what ordinarily people may understand.

What you have noticed in connection with the prices of certain commodities not really supported by the estimated inflation rate is actually a normal economic phenomenon. There is nothing wrong with the "strange-looking" prices nor anything wrong with the estimates of the rate of inflation. Let me explain the rationale behind the mystifying smokescreen in the following paragraphs.

First, inflation in economics means the TWO things:
(a) the PERSISTENT increase in the price level; and
(b) the AVERAGE of the price level.

So, from our first definition, the following things come to picture. One: inflation means general price level is rising. This never means prices of one, two, or so particular commodities are rising. This is meant to reflect the rise in the level of the cost of living you all in a country are generally experiencing. Suppose all the prices go up double; also suppose all the incomes go up double. What happens to you? Your rent was Rs 10,000 but now Rs 20,000; your monthly grocery expenditures cost you previously $ 8,000, but not cost you 16, 000; your salary was Rs 25, 000 but now Rs 40,000. Are you better off or worse off? Instead of paying Rs 5 for a cup of tea now you pay Rs 10; instead of paying Rs 50 for a good lunch now you pay Rs 100. And so on. Actually, you are neither better off nor worse off. It is something like you now have two beautiful bills with Gandhi's photo instead of only one bill.This should also mean production of goods and services in India has remained at the SAME LEVEL. This is something like what Einstein would call RELATIVITY. If two trains are moving at the same speed and you are in one, you will not know that the train is moving. On the other hand, if the trains are moving in the opposite directions, you will feel your train is moving at twice the actual speed at which it is moving.

Now come to this. Prices of all goods and services do not move in the same direction or at the same rates. Prices of some goods may be rising very fast. Prices of some goods may be rising slow. Prices of some goods may remain constant. And yet prices of a very few goods may even be falling. Do you feel the pinch in paying your bills? If you pay Rs 20 less on sugar because India has overproduced sugar, but you pay through your nose for bread, meat, vegetables, etc., while the price of soap and toothpaste may not have changed at all. You are still worse off. This is ONE SIDE of inflation. So during inflation in general prices of goods and services go up, some faster and some slower, while prices of a few commodities may remain constant, and prices of very few commodities may even be falling. This is a question of AVERAGE.

On the contrary, if the prices in general are not going up, but some prices are going very high up, maybe because of some shortage in domestic supply in India, probably because of reduced production or because of some obstructions in imports. This is NOT inflation.There is nothing GENERAL rise in price level.

Secondly, even if we have the ONE SIDE of inflation --generally price level is going up, but this is a short-lived phenomenon, say only for a few months or so, and then price level comes nearly back to the previous level. This is, again, NOT inflation. These are cases of simple spurts or increases in price level maybe because of some transitory economic or technological problems.

Hence, INFLATION means rise in the GENERAL price level and that price level increase in PERSISTENT.

Let us than define inflation: Inflation is the persistent increase in the general price level in a country.

Effects: Inflation affects different people differently. Most people are badly affected. Yet some people may be benefited. Suppose I lend you Rs 1,000,000 at an interest of 5% annually and the inflation is 10% annually. You are better off and I am worse off. You will pay me after one year an amount which will have half the value for me. So when you pay off all the money with interest (or cumulative interests), I will be getting an amount of money, say after two years, with which I will be able to buy commodities worth much less than what I could buy with the money I lent  you initially. Supposing you bought with the money you borrowed some property the price of which must have gone up because of inflation. So you sell that now for a larger sum, and you pay me even less than what you get after selling the commodity which you bought with my money in the first place, thereby making a profit out of borrowed money even without practically getting the money running in business. So inflation may make some people better off while makes most worse off.

Now a question about the rate of inflation. WHAT RATE? If there is NO inflation, this is not good for the country. For economic growth moderate rate of inflation is good. This provides fuel to the machine of production.

I hope this gives you some intuition about the answer to your question.

Best of luck.  

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Eklimur Raza

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It appears some students in this website are confused about elasticity of demand and the slope of the demand curve when they are trying to figure out why rectangular hyperbola comes up in case of unitary demand curve. First, they don't know that RH can be depicted in a positive quadrant of price,quantity plane. Secondly, they make the mistake that the slope of RH is constant at -1. Two points could help them: first, e=1 at each and every point of the RH, because the tangent at any point shows lower segment=upper segment (another geometric definition of e); yet slopes at different points,dQ/dP, are different; second, e is not slope but [(Slope)(P/Q)]in absolute terms. Caveat: only if we measure (log P) along the horizontal axis and (log Q) up the vertical axis, can we then say slope equals elasticity --in which case RH on P,Q plane is transformed into a straight-line demand curve [with slope= -tan 45 deg] on (log Q),(logP) plane, and e= -d(log Q)/d(log P). [By the way, logs are not used in college textbooks --although that is helpful in econometric estimation of elasticity viewed as an exponent of P, when demand equation is transformed into log-linear form.] I have not found the geometrical explanation I have given in any textbook followed in undergraduate and college classes in Canada (including the book followed in a university where I taught for a short time and in the book followed in George Brown College, Toronto, where I teach.

Experience

About 11 years' teaching economics and business studies, and also English, history and elementary French.Practical experience in a development bank, working with international donor agencies like the World Bank and the ADB. Experience in free-lance journalism, including Canada's "National Post."

Organizations
I teach micro- and macroeconomics at George Brown College (continuing education), Toronto, ON, Canada.

Publications
Many articles and editorials, on different subjects, in English newspapers. Recently an applied Major Research Paper, based on a synthesis of the Solow growth model and the Lewis two-sector model, has be accepted by Ryerson University, Toronto. Professors Thomas Barbiero and Eric Cam, Ryerson University, accepted the paper.

Education/Credentials
Master degree in Interantional Economics and Finance and diploma with honours in Business Administration from Canada.

Awards and Honors
Received First Prize in an inter-university Literary Contest.

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