Insights into Economics=5

Insight into Economics-5

Now let us move into price movements in an Economy. Before that, something that had been left out in demand/supply phenomenon will come handy to get a better grasp over the price movements.

Elasticity of demand is the percentage change in demand to percentage change in Price. If we let * as the symbol associating the word change, P as price and Q as the demand for the  product then,  Elasticity of demand E =- (*Q/Q)/(*P/P). This gives the change in demand of a product for unit change in price level for that product. It should be noticed that the price and quantity are negatively correlated. Positive change in price level create reduction in demand and vice-versa.

The general change in price level is termed Inflation. Inflation is measured using the index called Consumer Price Index, CPI in short. CPI is measured as the cost of a basket of goods and services  the products chosen in the basket representing the general price levels of all goods and services of an economy. For example resins can be a good in the economy depicting the  price of Paints and many other products where resin is an input. An year is chosen as the starting point from where the  Index starts, which is called the Base Year.

Suppose if X is the cost of the basket of goods in the base year 1, then the CPI for that year is X/X=1

Now if the price of the basket of goods in year 2 is (X+a) then CPI for the second year is ((X+a)/X). The reciprocal or inverse of the CPI will give the Purchasing Power of the currency. That is how much of wealth a unit of the currency really holds. This happens since the purchasing power can get eroded as the economy picks up inflation. So one can calculate ones wealth by generally inverting CPI and multiplying it by the total value ones asset each year. So if inflation is not controlled then there can be erosion in ones personal wealth as time goes on.

When CPI is the measure of price inflation at the retail level, Whole Sale Price Index is the measure for price increases at the Input level. WPI gives an indication of how input price to the products have risen in the economy that particular year.

Price increases at input levels at input levels are important policy measuring sticks. Governments usually uses a policy tool called Automatic Stabilizers to control price rises at the input level so the general price inflation in the economy can be controlled. This is by taxing the Input providers to the tune of price hikes they create and this deters them from raising prices at input level sot that the price increases at retail levels will be minimal. If they raise prices at input levels then the taxes they are burdened will nullify the profits they expect from price increases at that level. This is shortly termed Auto Stabilizers.

There are many other methods to control inflationary pressures in an Economy which will be discussed at the appropriate time when the phenomena attached to them appear.