Hey folks, welcome to CCB. In today’s post we’ll have a look at Dosa Economics. Former RBI Governor Mr. Raghuram Rajan used Dosa as a measure to explain how inflation and interest rates work in the economy.
Let’s understand this with an example. Imagine you’ve got INR 100,000 and you deposit it in the bank and the bank pays you an annual interest of 10%. Therefore, at the end of the you’ve got INR 1,10,000.
Now assume instead of depositing INR 100,000 in bank you bought dosas worth INR 100,000 and price of each dosa is INR 50. Therefore, the numbers of dosas you bought are, INR 100,000 divided by INR 50 = 2000 dosas. Now assume that after one year the price of dosa moves from INR 50 to INR 55. Well, now assume that instead of buying dosa for INR 100,000, you decided to deposit that money in bank and thought of buying dosas a year later. Well, at the end of the year you’ve got INR 1,10,000 as the bank paid you 10% annual interest. Okay, now imagine you bought dosas for INR 1,10,000 and over the course of the year the price of dosa moved to INR 55 due to inflation (oil price, LPG price, salary hike of cook, hike in rent of the hotel etc.). So this time the number of dosas you can buy is INR 1,10,000 divided by INR 55 = 2000 dosas.
Well, if you look at the above paragraph you can see that irrespective of when you bought the dosas, whether you got it at the starting of the year or at the end of the year post receiving the INR 100,000 + INR 10,000 interest, the number of dosas you could buy is the same, that is 2000 dosas.
Well, now assume the bank paid you 8% annual interest and inflation rate is low and price of dosa moved to INR 53 per unit. Substituting this new value in the above equations gives you following results.
8% of INR 100,000 is INR 8000. And INR 1,08,000 divided by INR 53 = 2037.73.
Therefore, if you buy the dosa at the starting of the year when price of each dosa is INR 50 and you have INR 100,000 you can buy 2000 dosas but if you plan to deposit that money in bank and decide to buy the dosa post one year after receiving an annual interest of 8%, you can buy 2037 dosas. Yes, that is 37 extra dosas.
Therefore, according to Mr. Raghuram Rajan, high interest rate and high inflation doesn’t reap anything and decent interest rate and minimum inflation can be beneficial.