Ramesh Singh Test: Inflation and Business Cycle - UPSC MCQ

Statement-I correctly describes the significance of the Producer Price Index (PPI) as a more reliable indicator of inflation when compared to the Wholesale Price Index (WPI) and Consumer Price Index (CPI). The PPI focuses on the prices received by producers for their products, providing a different perspective on inflation dynamics.

However, Statement-II inaccurately suggests that the introduction of India's official Housing Price Index (HPI) in 2007 was a crucial step in aligning with global economic indicators. In reality, the HPI, known as NHB Residex, primarily focuses on housing price movements within India and does not directly relate to global economic indicators or comparisons like the Producer Price Index does.

1. GDP Deflator : Excludes services Incorrect. The GDP deflator includes the entire range of goods and services produced in the economy, making it a comprehensive measure of inflation.

2. Wholesale Price Index (WPI) : Excludes services Correct. In India, the Wholesale Price Index (WPI) excludes services.

3. Consumer Price Index (CPI) : Includes only goods and services purchased by households Correct. The Consumer Price Index (CPI) includes only goods and services purchased by households for consumption, such as food, clothing, health, and education.

4. Base Effect : Measures the influence of inflation in the current year on the previous year Incorrect. The base effect refers to the influence of the previous year's price level increase (last year's inflation) on the current year's price level increase (current inflation).

Thus, only pairs 2 and 3 are correctly matched.

Core inflation refers to a sustained, across-the-board price increase in an economy, excluding certain goods and services like energy and food articles. This term is popular in Western economies and helps in understanding the underlying trend of inflation by excluding volatile components. Core inflation is a crucial indicator for policymakers to gauge the true inflationary pressures in an economy.

- Statement 1: This statement is correct. Overheating in an economy, following a boom, can lead to a downturn in aggregate demand, falling production levels, and stagnant employment growth. This is because the initial boom often results in rising prices and inflation, which eventually reduces demand and production, leading to higher unemployment.

- Statement 2: This statement is also correct. During a recession, there is generally a fall in demand as economic activities decline. To sustain business under such conditions, industries often resort to price cuts. Additionally, low or falling inflation and rising unemployment are common traits of a recession.

- Statement 3: This statement is correct as well. A double-dip recession occurs when an economy enters into recession, experiences a brief recovery, and then falls back into recession again. This pattern results in GDP growth turning negative after a short period of positive growth, often due to reduced demand from previous layoffs and spending cutbacks.

All three statements accurately describe the economic phenomena related to overheating, recession, and double-dip recession. Therefore, the correct answer is Option D.

A growth recession characterizes an economy where the rate of job loss surpasses job creation, giving the impression of a recession even when there is positive GDP growth. This phenomenon has been observed in various economies, including the U.S. economy between 2002 and 2003, and has become more relevant in the aftermath of financial crises, such as those since 2008 in Euro-American economies.

1. Demand-Pull Inflation - Creation of extra purchasing power over the same level of production: Correct. This is the monetarist view of demand-pull inflation, where extra purchasing power leads to inflation.

2. Cost-Push Inflation - A mismatch between demand and supply pulls up prices: Incorrect. Cost-push inflation occurs due to an increase in the production cost (e.g., wages and raw materials), not due to a mismatch between demand and supply.

3. Low Inflation - Large and accelerating price increases: Incorrect. Low inflation is slow and predictable, often referred to as 'creeping inflation', not characterized by large and accelerating price increases.

4. Hyperinflation - Very high inflation running in the range of double-digit or triple digit: Incorrect. Hyperinflation involves extremely high and accelerating inflation, often with annual rates in millions or trillions, not just double or triple digits.

So, only the first pair is correctly matched.

Statement-I correctly defines inflation as a sustained rise in the general level of prices over time. This definition aligns with the common understanding of inflation in economics. Statement-II accurately describes hyperinflation as an extreme form of inflation characterized by very high and accelerating rates, often leading to astronomical price increases within a short period. Hyperinflation is indeed a subtype of inflation known for its rapid and extreme nature. Therefore, both statements are correct, and Statement-II provides additional, explanatory information related to the intensity and speed of price increases in hyperinflation scenarios.

Hyperinflation is a severe form of inflation characterized by a rapid and excessive increase in prices. Annual inflation rates in hyperinflation scenarios can reach extreme levels, often in the millions or even trillions. This leads to a situation where prices escalate rapidly, sometimes on a daily basis. Hyperinflation can have devastating effects on an economy, causing a loss in the value of the local currency and leading to economic instability.

Let's analyze each statement for its accuracy:

1. Bottleneck inflation is categorized under cost-push inflation.

- This statement is incorrect. Bottleneck inflation occurs when supply falls drastically while demand remains the same, typically due to supply-side hurdles, hazards, or mismanagement, which places it under the category of 'demand-pull inflation' rather than cost-push inflation.

2. Core inflation excludes the prices of energy and food articles while calculating inflation.

- This statement is correct. Core inflation is a measure of inflation that excludes certain items that face volatile price movement, specifically energy and food articles, to give a clearer picture of the trend in inflation.

3. Stagflation is a situation where both inflation and unemployment are high.

- This statement is correct. Stagflation describes an economic condition characterized by high inflation and high unemployment, which defies the traditional Phillips Curve relationship that suggests an inverse relationship between inflation and unemployment.

Thus, the correct statements are 2 and 3 only.

Answer: Option C

Statement-I is incorrect because it describes symptoms of economic slowdown or recession, not overheating. Overheating involves rising inflation, increased production, and high employment.

Statement-II is correct as it accurately defines a growth recession, where the economy grows too slowly, leading to job losses despite positive GDP growth.

1. Bottleneck Inflation - Arises due to increased demand: Incorrect. Bottleneck inflation occurs when the supply falls drastically while demand remains the same, due to supply-side hurdles or mismanagement, also known as structural inflation. It is associated with demand-pull inflation but is not directly caused by increased demand.

2. Core Inflation - Excludes energy and food articles: Correct. Core inflation is a measure that excludes volatile items such as energy and food articles to provide a clearer picture of long-term inflation trends.

3. Phillips Curve - Shows trade-off between inflation and unemployment: Correct. The Phillips Curve illustrates the inverse relationship between inflation and unemployment, suggesting that higher inflation typically corresponds with lower unemployment and vice versa.

4. Stagflation - High inflation and high unemployment simultaneously: Correct. Stagflation is a situation where an economy experiences high inflation and high unemployment at the same time, which is contrary to the usual inverse relationship suggested by the Phillips Curve.

Correctly matched pairs: 2, 3, and 4. Only the first pair is incorrectly matched.

Hence, the correct answer is Option C: Only three pairs.

1. Statement 1 is correct: The Producer Price Index (PPI) is indeed considered a better measure of inflation compared to the Wholesale Price Index (WPI) and the Consumer Price Index (CPI). This is because PPI measures the average changes in prices received by domestic producers for their output, which provides a more accurate reflection of inflationary trends affecting production costs.

2. Statement 2 is correct: India's official Housing Price Index (HPI), known as NHB Residex, was developed by the National Housing Bank (NHB). It is published on a quarterly basis for 50 cities, and the base year for this index is 2012-13. This information aligns with the development and current publication practices of the NHB Residex.

3. Statement 3 is incorrect: The current inflation measurement at the Wholesale Price Index (WPI) does not include the price changes in the tertiary sector. The WPI only includes the price movements of the commodity-producing sectors, which are the primary and secondary sectors. The tertiary sector, which comprises services, is not represented in the WPI.

Therefore, the correct answer is Option B: 1 and 2 Only.

1. Growth Recession - Economy growing slowly, more jobs lost than created (Incorrect)

Explanation: A growth recession describes an economy growing so slowly that more jobs are lost than created, despite positive GDP growth. The term was used to describe the U.S. economy between 2002 and 2003.

2. Double-Dip Recession - Recession, recovery, and recession again (Correct)

Explanation: A double-dip recession occurs when an economy falls into recession, recovers briefly, and then falls into recession again, with GDP growth turning negative after a short period of positive growth.

3. Overheating - Strong upward fluctuation in economic activities (Correct)

Explanation: Overheating in an economy refers to a strong upward fluctuation in economic activities where demand exceeds production, leading to inflation and other symptoms like declining demand and production, and rising unemployment.

4. Recession - General fall in demand, low or falling inflation (Correct)

Explanation: A recession is characterized by a general fall in demand, low or falling inflation, rising unemployment, and price cuts by industries to sustain business. It is a milder form of depression and can lead to depression if not managed properly.

Thus, the correctly matched pairs are 2, 3, and 4.

1. Producer Price Index (PPI) - Better measure of inflation compared to WPI and CPI: Correct. PPI is considered a better measure of inflation as it reflects the prices received by producers for their goods and services, providing a more accurate picture of inflation.

2. Housing Price Index (HPI) - Covers 50 cities including 18 State/UT capitals: Correct. The NHB Residex covers 50 cities, including 18 State/UT capitals and 37 Smart Cities, and is published quarterly with 2012-13 as the base year.

3. Service Price Index (SPI) - Measures price changes in the services sector: Incorrect. There is no current index to measure the price changes in the services sector in India despite the growing contribution of the tertiary sector to GDP.

4. Depression - Characterized by extremely high aggregate demand: Incorrect. A depression is characterized by extremely low aggregate demand, which leads to deceleration of economic activities, lower inflation, shrinking employment opportunities, and forced labor cuts.

Thus, only two pairs are correctly matched.

The GDP deflator serves as a measure of inflation, revealing the increase in GDP value resulting from inflation between the base year and the current year. It encompasses the entire range of goods and services produced in the economy, making it a comprehensive measure of inflation compared to other indices like the Wholesale Price Index (WPI) and the Consumer Price Index (CPI).

- Statement 1: Correct. Demand-Pull Inflation occurs when the demand for goods and services exceeds their supply, leading to a rise in prices. This can happen when consumers have more purchasing power over the same level of production.

- Statement 2: Incorrect. Cost-Push Inflation occurs when there is an increase in the cost of production, such as higher wages or more expensive raw materials, which in turn causes the prices of final goods and services to rise.

- Statement 3: Correct. Hyperinflation is a situation where the increase in prices is extremely rapid and out of control, often reaching rates of millions or even trillions annually. It happens over a very short period, with prices sometimes shooting up overnight.

Therefore, the correct answer is Option B: 1 and 3 Only.

Statement-I correctly defines the concept of an inflationary gap, which is the excess of total government spending over the national income, leading to inflationary pressures in the economy.
Statement-II accurately describes the concept of a deflationary gap, which occurs when total government spending is less than the national income, leading to deflationary pressures in the economy.
Therefore, both statements are correct, and Statement-II logically explains Statement-I.

Statement-I is correct because the GDP deflator is indeed considered a comprehensive measure of inflation as it covers all goods and services produced in the economy, unlike indices like the WPI and CPI which exclude certain items. Statement-II is also correct as it accurately describes the base effect in inflation calculations, where the previous year's inflation can impact the current year's inflation rate, leading to adjustments based on past trends. Statement-II further explains why the GDP deflator is a more robust measure of inflation, making option (a) the correct choice.

The Indian government proposed the Producer Price Index (PPI) in 2003-04 as a more accurate measure of inflation compared to the Wholesale Price Index (WPI) and Consumer Price Index (CPI). The PPI is designed to reflect price changes at the producer level, providing insights into inflation dynamics from a production standpoint.

1. **The GDP deflator encompasses the entire range of goods and services produced in the economy, making it a more comprehensive measure of inflation than the Consumer Price Index (CPI).**
This statement is correct. The GDP deflator includes all goods and services produced in the economy, unlike the CPI which only includes goods and services purchased by households for consumption.

2. **The base effect can cause the year-on-year inflation rate to appear lower if the previous year's inflation rate was high.**
This statement is correct. The base effect refers to the impact of the previous year's price level on the current year's inflation rate. A high inflation rate in the previous year can make the current year's inflation rate appear lower even if there is a similar increase in absolute prices.

3. **Inflation generally benefits creditors and harms debtors by increasing the real value of repayments.**
This statement is incorrect. Inflation actually redistributes wealth from creditors to debtors, as the real value of money repaid by the debtors is lower due to the decreased purchasing power of money.

Therefore, the correct answer is **Option B**.