Can a cup of tea explain inflation? This question came to my mind this morning when I got to know that our canteen guy had hiked the price of a simple tea cup by 1 Re to Rs 5 citing inflation. Now without undermining anyone’s intelligence, I can safely assume that the only thing that guy knows about inflation is that it is bad and it raises prices. So he needs to follow suit as his raw materials will also cost more. This is partially correct. Let’s try to look at economics taking this very cup of tea as the base.
What is inflation firstly? Indeed it’s responsible for rising prices but then some amount of it is always desired. In absence of any inflation, a vicious economic downturn can grip a country. Take that canteen guy, for example. Inflation led him to raise prices and hence his disposable income. He will have more money to spend or save and hence more to contribute to the economy. This is what inflation does: propping up disposable incomes of individuals. Its reverse is deflation: prices of everything start falling and that leads to lesser and lesser amount of money being available in the economy.
Now the potent question is: How much inflation? In our context, an inflation of 5-6 percent is certainly desirable. However, as has happened in the past few months, inflation has touched even 12 percent once. This was mainly on the account of too much money in the economy chasing too few goods. Inflation, however, has now dropped to 6.84% ironically due to the lack of money in the economy. No wonder, the government and RBI are trying to infuse liquidity in the market big time.
Inflation is also good for employment as has been illustrated by the Philips curve. It plots rate of inflation against rate of unemployment depicting their inverse relationship. Certain exceptions such as stagflation (stagnant growth and high inflation) do occur but are rare.
Inflation, if under control, can certainly help in raising savings and investment in any economy. Now the question is: Can inflation be actually controlled? The answer is: NO! Inflation cant be controlled but can be managed through measures of credit control in an economy, like RBI increasing CRR when inflation was rising. The key lies in knowing which inflation to manage at the time: supply side or demand side? In our case earlier this year, we were attacking demand side inflation whereas the problem lied in low supply.
Coming back to the cup of tea; prices of tea rarely rise during inflation. Tea companies, however, reduce the weight of their packs without informing the innocent customers. Tea vendors, however, know this. That is the reason why they add a minutely less amount of tea in every cup thereby offsetting their potential losses. Now, I am not generalizing here at all; it’s just what I have observed in my interactions with some vendors. Now, they aren’t really at a loss but they raise prices which actually gives them more economic profit. Now you may argue that milk is also used in tea and it does cost more during inflation. However, a milk packet is used to make 4-5 tea cups. A 1 Re rise in one milk packet would hardly amount to a 20 paise rise in one tea cup. Net result: still profit.
Inflation is a major impact phenomenon of macroeconomics. Even a layman knows basically what it is. However, the key lies in understanding its basic nuances and not just castigate or use it. Till the time that happens, the price of a revered cup of tea will keep rising (even though tea is least affected by inflation) and our canteenwala will happily keep on minting extra rupees citing… well u know by now- what.