What causes inflation

Let us say I have a product which I can produce at a rate 10 per day. However there is demand for 15 units a day. Due to higher demand & lower availability, I can find 10 people who are ready to pay more to get my product on that day by paying higher price. So the price of my product will be proportionately higher compared to the delta in demand and supply.
==>What government does is it makes sure there is less money available with the people; so that there is lesser demand so the prices are in control. Keeping fiscal deficit within x % of GDP. So that inflation is low.
==>What RBI does is it makes sure that credit is available at an higher price. So people are discouraged from buying more
There is another aspect that is completely ignored in textbook economics.
i. I as a producer / consumer have to say pay money as a bribe. So as a producer I ll have to adjust that price in the cost of product. And as a consumer the product costs shoots up by that amount. That results increasing producing / buying price of the product.
ii. With our paying bribe, money changes hands without producing any work or creating any value for anyone. It creates consumers [bribe takers] with higher availability of money and can be spent for purchasing same all products that common consumer buys.
That in turn causes increased demand. So compared to deficit, corruption causes at least double shooting up of inflation.
Does this answer lower inflation in developed economies despite higher deficit & higher inflation despite lower deficit in India?

Comments

Saikat Prabhakar said…
Yes it does :) ...would appreciate more insight into it though..
August 9, 2010 at 2:40 PM
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