Inflation

Cost-push Inflation: As the name suggests, if there is increase in the cost of production of goods and services, there is likely to be a forceful increase in the prices of finished goods and services. For instance, a rise in the wages of laborers would raise the unit costs of production and this would lead to rise in prices for the related end product. This type of inflation may or may not occur in conjunction with demand-pull inflation.

Cost-push inflation

Rising inflation can prompt employees to demand higher wages, to keep up with consumer prices. Rising wages in turn can help fuel inflation. In the case of collective bargaining, wages will be set as a factor of price expectations, which will be higher when inflation has an upward trend. This can cause a wage spiral.[22] In a sense, inflation begets further inflationary expectations

Demand-Pull Inflation

According to the demand-pull theory, prices rise in response to an excess of aggregate demand over existing supply of goods and services. The demand-pull theorists point out that inflation (demand-pull) might be caused, in the first place, by an increase in the quantity of money, when the economy is operating at full employment level. As the quantity of money increases, the rate of interest will fall and, consequently, investment will increase. This increased investment expenditure will soon increase the income of the various factors of production. As a result, aggregate consumption expenditure will increase leading to an effective increase in the effective demand. With the economy already operating at the level of full employment, this will immediately raise prices, and inflationary forces may emerge. Thus, when the general monetary demand rises faster than the general supply, it pulls up prices (commodity prices as well as factor prices, in general). Demand-pul

l inflation, therefore, manifest itself when there is active cooperation, or passive collusion, or a failure to take counteracting measures by monetary authorities. Demand-pull or just demand inflation may be defined as a situation where the total monetary demand persistently exceeds total supply of real goods and services at current prices, so that prices are pulled upwards by the continuous upward shift of the aggregate demand function.

Causes of Demand-Pull Inflation

It should be noted that the concept of demand-pull inflation is associated with a situation of full employment where increase in aggregate demand cannot be met by a corresponding expansion in the supply of real output. There can be many reasons for such excess monetary demand:

1. Increase in Public Expenditure. There may be an increase in the public expenditure (G) in excess of public revenue. This might have been made possible (or rendered necessary) through public borrowings from banks or through deficit financing, which implies an increase in the money supply.

2. Increase in Investment. There may be an increase in the autonomous investment (iI in firms, which is in excess of the current savings in the economy. Hence, the flow of total expenditure tends to rise, causing an excess monetary demand, leading to an upward pressure on prices.

3. Increase in MPC. There may be an increase in the marginal propensity to consume (MPC), causing an excess monetary demand. This could be due to the operation of demonstration effect and such other reasons.

4. Increasing Exports and Surplus Balance of Payments. In an open economy, an increasing surplus in the balance of payments also leads to an excess demand. Increasing exports also have an inflationary impact because there is generation of money income in the home economy due to export earnings but, simultaneously, there is reduction in

the domestic supply of goods because products are exported. If an export surplus is not balanced by increased savings, or through taxation, domestic spending will be in excess of the value of domestic output, marketed at current prices.

5. Diversification of Goods. A diversion of resources from the consumption goods sector either to the capital goods sector or the military sector (for producing war goods) will lead to an inflationary pressure because while the generation of income and expenditure continues, the current flow of real—output decreases on account of high gestation period involved in these sectors. Again, the opportunity cost of war goods is quite high in terms of consumption goods meant for the civilian sector. This leads to an excessive monetary demand for the goods and services against their real supply, causing the prices