Inflation: Causes, Types, Control & Business Impact

Core Concepts

What is Inflation?

Inflation is the sustained increase in the general price level of goods and services over time, measured as a percentage change in a price index (e.g., CPI or GDP deflator). It erodes purchasing power: ₹100 today buys less than ₹100 five years ago.

Key Idea: Inflation ≠ price increases for all goods (e.g., fuel prices may rise while smartphone prices fall). It’s about the average price level.

Types of Inflation

1. Demand-Pull Inflation

Definition: Occurs when aggregate demand (AD) exceeds aggregate supply (AS) at the full-employment level, pulling prices up.

flowchart TD
    A["High Demand"] --> B["Excess AD over AS"]
    B --> C["Firms raise prices"]
    C --> D["Price Level ↑"]
    D --> E["Inflation"]

Real-World Example: Kathmandu Traffic & Real Estate

• Scenario: Post-earthquake reconstruction (2015–2017) + remittance boom (₹10B/month in 2022) → demand for housing, vehicles, and land surged.
• Outcome: Land prices in Thapathali rose 30% YoY (2021–2022), while used-car prices in Pokhara jumped 25% due to limited supply.
• Policy Response: NIBL (National Infrastructure Bank of Nepal) increased housing loans, but this fueled further demand-pull pressure.

Worked Example: eSewa Fee Hikes

• Before: eSewa charged ₹5 for a ₹100 electricity bill payment.
• After: Due to demand for digital payments (₹2.5T in 2023) and cost of maintaining servers, fees rose to ₹10.
• Why? High transaction volume (AD ↑) + fixed server capacity (AS stagnant) → demand-pull inflation for digital services.

2. Cost-Push Inflation

Definition: Caused by rising production costs (wages, raw materials, energy) that firms pass on to consumers.

Real-World Example: Nepal’s Fuel Price Hikes (2022)

• Cause: Global oil prices surged due to Russia-Ukraine war (crude oil ↑ from $70/bbl to $120/bbl).
• Impact:
  • Transport costs for Daraz/Nepal Post rose 20%.
  • Manufacturing costs for cement (₹800/50kg → ₹1,000/50kg) and textiles increased.
  • Inflation in 2022: 7.8% (highest in a decade).
• Who Benefits? Oil importers (NOC, HPCL) earned higher profits.

Worked Example: Ncell Tariff Adjustments

• Before: 1GB data cost ₹120 (2021).
• After: Due to rising spectrum costs (₹500M/year for licenses) and higher server maintenance, price rose to ₹150 (2023).
• Result: Cost-push inflation for telecom services.

3. Built-In Inflation (Wage-Price Spiral)

Definition: A self-perpetuating cycle where:

1. Workers demand higher wages to offset inflation.
2. Firms raise prices to cover wage hikes.
3. Workers demand even higher wages → inflation accelerates.

Real-World Example: Nepal’s Public Sector Strikes (2020–2023)

• Trigger: Teachers and health workers demanded 15% salary hikes due to inflation (CPI = 6.2% in 2023).
• Outcome:
  • Government granted hikes → public sector wage bill rose by ₹20B.
  • Private firms (e.g., hotels, hospitals) raised prices to offset costs.
  • Result: Built-in inflation in services sector.

Measuring Inflation

Key Price Indices

Worked Example: Calculating CPI for Nepal (2022–2023) Assume a basket with:

• Rice (50%): ₹60/kg (2022) → ₹70/kg (2023)
• Diesel (30%): ₹150/liter (2022) → ₹220/liter (2023)
• Smartphone (20%): ₹20,000 (2022) → ₹18,000 (2023)

Step 1: Calculate basket cost for each year.

• 2022: $(50\times 60)+(30\times 150)+(20\times 20,000)=₹435,000$
• 2023: $(50\times 70)+(30\times 220)+(20\times 18,000)=₹451,000$

Step 2: Compute CPI (base year 2022).

• ${\text{CPI}}_{2023}=\frac{451,000}{435,000}\times 100=103.7\%$
• Inflation Rate: $(103.7-100)=3.7\%$

(Note: Real CPI in Nepal uses a basket of 120 items tracked by NSB.)

Causes of Inflation

Primary Causes

Secondary Causes (Nepal-Specific)

• Monsoon Failures: Food inflation (e.g., maize prices ↑ 40% in 2021).
• Trade Deficits: Imported inflation (e.g., wheat prices rise due to global shortages).
• Black Money: Unreported cash → excess liquidity → demand-pull.

Controlling Inflation

Monetary Policy Tools

Visual: Monetary Policy Transmission Mechanism

flowchart TD
    A["NBR Increases Repo Rate"] --> B["Banks Borrow Costly Funds"]
    B --> C["Banks Reduce Loans"]
    C --> D["AD Decreases"]
    D --> E["Inflation Falls"]

Fiscal Policy Tools

Worked Example: Nepal’s Fuel Subsidy Cut (2023)

• Before: Government subsidized fuel at ₹100/liter (market price: ₹180).
• After: Subsidy removed → price rose to ₹180.
• Impact:
  • Cost-push inflation for transport/logistics (Daraz delivery costs ↑).
  • Revenue Gain: Government saved ₹15B/year.
  • Social Cost: Poor households’ transport costs rose 50%.

Inflation in Business Context

Impact on Firms

Strategies for Businesses

1. Pass-Through Pricing: Raise prices to offset costs (e.g., Ncell tariff hikes).
2. Economies of Scale: Bulk purchasing to reduce per-unit costs (e.g., Patanjali in Nepal).
3. Diversify Suppliers: Avoid reliance on single high-cost sources (e.g., Daraz using local warehouses).
4. Long-Term Contracts: Lock in prices for raw materials (e.g., cement firms with quarry owners).

In the Real World

1. eSewa & Digital Inflation

   • Idea Used: Demand-pull inflation due to high transaction volume.
   • How? As more Nepalis used eSewa (₹2.5T in 2023), the platform’s server costs and fraud detection expenses rose. To cover these, eSewa increased fees from ₹5 → ₹10 for bill payments, reflecting inflation in digital service costs.

2. Ncell & Telecom Pricing

   • Idea Used: Cost-push inflation from rising spectrum costs.
   • How? Ncell’s ₹500M/year spectrum license fee (auctioned by NTA) and higher data center costs led to a ₹30 increase in 1GB data prices (2022–2023). This directly increased the inflation rate for telecom services in Nepal’s CPI basket.

3. Daraz & Logistics Costs

   • Idea Used: Supply-chain cost-push inflation.
   • How? The 2022 fuel price hike (₹150 → ₹220/liter) increased Daraz’s delivery costs by 20%. To maintain margins, Daraz:
     • Raised minimum order values from ₹1,500 → ₹2,000.
     • Introduced dynamic pricing (higher fees for remote areas).
   • Result: Inflation in e-commerce delivery fees was passed to consumers.

4. Nepal Rastra Bank (NBR) & Monetary Policy

   • Idea Used: Monetary policy tools to control inflation.
   • How? When inflation hit 7.8% in 2022, NBR:
     • Increased repo rate from 6% → 8% (making loans expensive).
     • Sold ₹50B in T-bills to absorb excess liquidity.
   • Outcome: Inflation fell to 6.2% in 2023, but business loans became costlier (SME interest rates rose from 10% → 14%).

Exam Tip

How to Score Full Marks

1. Define Clearly: Always start with a precise definition (e.g., “Inflation is a sustained increase in the general price level...”).
2. Use Diagrams: Draw AD-AS curves for demand-pull, supply shifts for cost-push, and wage-price spirals for built-in inflation.
3. Link to Nepal: Every answer must include one real-world example (e.g., fuel prices, eSewa fees, Ncell tariffs).
4. Policy Mix: For control measures, combine monetary and fiscal tools (e.g., “NBR should increase repo rates and the government should cut subsidies”).
5. Maths for Measurement: Practice CPI/GDP deflator calculations—examiners love numerical examples.
6. Avoid Confusion:
   • ❌ “Inflation is when prices rise.” → ✅ “Inflation is a sustained increase in the general price level...”
   • ❌ “Demand-pull is when supply decreases.” → ✅ “Demand-pull occurs when aggregate demand exceeds aggregate supply at full employment.”

Common Mistakes to Avoid

• Mixing types: Don’t say “cost-push is when demand increases.”
• Ignoring real-world data: Always tie theory to Nepal (e.g., “Like in 2022, when oil prices rose...”).
• Overlooking secondary effects: If asked about impact of inflation, discuss winners (debtors, exporters) and losers (fixed-income groups, savers).