Demand Shock & Supply Shock: Decoding Inflationary Pressures in India

Analyzing the causes of inflation in India using demand and supply concepts

India is a growing economy which has seen a rise in its inflation rates since 2018 when it was 3.4% per annum growing to 6.95% per annum in the year 2023. There are various reasons for the inflation in India, two of the main causes being demand-pull inflation and supply shocks. The statistics show that there will be continuous increase in the average prices of goods and services, at least predicted till the year 2028.

This means a basket of everyday items people could buy for ?100 last year might cost ?105 or more today. This erodes the purchasing power of the rupee, making it harder for your money to stretch as far. The Reserve Bank of India (RBI) is tasked with managing inflation and maintaining price stability through measures like setting interest rates.

Demand-pull inflation (demand shock) occurs when the overall demand for goods and services in an economy exceeds the available supply. This imbalance leads to businesses raising prices to meet the higher demand, causing inflation. According to economists, demand-pull inflation is “too many dollars chasing too few goods”.

Scenario: Imagine the Indian economy is experiencing a strong economic boom. Consumer incomes are rising, and people have more money to spend. This increased purchasing power creates a surge in demand for various goods and services, including two-wheeler vehicles (motorcycles and scooters). Impact on Prices: With a sudden rise in demand for two-wheelers, manufacturers might struggle to keep up with production. This creates a shortage in the market. Since demand is high and supply is limited, two-wheeler manufacturers can increase their prices. Consumers, with more money to spend, may still be willing to buy these vehicles at the higher price point.

During real-time India witnessed a similar situation in the post-pandemic economic recovery period (around 2021-2022). Rising disposable incomes and pent-up demand led to a surge in two-wheeler sales.

Supply shocks are sudden disruptions in the production or distribution of goods and services. These disruptions can cause a significant shift in the supply curve, leading to inflation.

Scenario: Imagine a sudden and unexpected monsoon flood devastates major onion-growing regions in India. This natural disaster significantly reduces the overall supply of onions in the market. Impact on Prices: With a drastic drop in onion supply, even if the demand for onions remains the same, there won't be enough onions available to meet that demand. This shortage pushes prices upwards. Consumers are willing to pay a higher price to obtain this essential food item.

During real-time India has experienced such fluctuations in onion prices due to supply shocks. For instance, in 2020, heavy monsoon rains damaged onion crops, leading to a limited supply and a spike in onion prices across the country. This contributed to a rise in the overall inflation rate in India during that period.

Additionally, there are two types of supply shocks, positive and negative. Positive supply shocks occur due to events that increase supply, leading to lower prices (like a technological innovation that reduces production costs). However, negative supply shocks, like natural disasters, trade disruptions, or resource scarcity, are more common and can cause significant inflationary pressures.

Understanding the causes of demand-pull inflation is crucial for policymakers to implement measures like raising interest rates or increasing supply to control inflation, while understanding supply shocks is crucial for analyzing inflation trends and formulating effective economic policies to maintain price stability.

CITATIONS

TVS Motor Company Ltd. (2024, May 10). The Economic Times. Retrieved from https://economictimes.indiatimes.com/tvs-motor-company-ltd/stocks/companyid-12940.cms

Pti. (2023, August 6). Onion prices likely to hit ?60-70/kg in September: report. The Hindu. Retrieved from https://www.thehindu.com/news/national/onion-prices-likely-to-hit-60-70kg-in-september-report/article67160936.ece

Chen, J. (2024, January 11). What is Demand-Pull inflation? Investopedia. Retrieved from https://www.investopedia.com/terms/d/demandpullinflation.asp

What are economic shocks? (n.d.). Reference Library | Economics | Tutor2u. Retrieved from https://www.tutor2u.net/economics/reference/what-are-economic-shocks

Unlock the Potential of Legal Expertise with LegalMantra.net - Your Trusted Legal Consultancy Partner”

Article Compiled by:-

(LegalMantra.net Team)

Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including Newspapers, Journals, Bare Acts, Case Materials , Charted Secretary, Research Papers etc.