Group members: PriyankaSahil madanSushant dahiyaShubham das Bharti

Inflation: Cost Push And Demand Pull

CONTENTS

About inflation Causes of inflation Types of inflation Effects of inflation Inflation rate Controlling inflation Conclusion & consequences of inflation

ABOUT INFLATION ??• Inflation is persistent, continuous and

substantial a rise in general level of price of goods and services in the country over period of time,

• As the cost of goods and services increase, the value of a currency declines because the person won’t be able to purchase as much with that currency as they could have last month or year.

• It has worst impact on consumers

DEFINITIONS

According to C.CROWTHER, “Inflation is State in which the Value of Money is Falling and the Prices are rising.”

In Economics, the Word inflation Refers to General

rise in Prices Measured against a Standard Level of Purchasing Power.

CAUSES OF INFLATION

1. Cost Push Inflation Or Supply Side Inflation

2. Demand Pull Inflation

1. COST PUSH INFLATION• Inflation caused by an increase in prices of

inputs like labour, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level. This is in essence cost push inflation.

• example- if wages of workers are raised then the unit cost of production also increases.

DIAGRAM SHOWING COST PUSH INFLATION

CAUSES OF COST PUSH INFLATION• Increased costs of raw materials• Increased wages• Failure to replace capital goods as they age,

reducing its productivity, or increasing• Its maintenance costs• Falling productivity of workers

• Higher Taxes. Higher VAT and Excise duties will increase the prices of goods. This price increase will be a temporary increase.

• Higher Food Prices. In western economies food is a smaller % of overall spending, but in developing countries, it plays a bigger role. 

Many cost push factors like rising energy prices, higher taxes, effect of devaluation may prove temporary. Therefore, Central Banks may tolerate a higher inflation rate if it is caused by cost push factors. For example, in 2011, CPI inflation reached 5%, but the Bank of England kept base rates at 0.5%. This shows they are confident (hopeful) inflation will soon fall.

Other economists may fear that temporary cost push factors may influence inflation expectations. If people see higher inflation, they may bargain for higher wages and thus the temporary cost push inflation becomes sustained.

COST PUSH INFLATION – TEMPORARY OR PERMANENT?

The government could pursue deflationary fiscal policy (higher taxes, lower spending) or monetary authorities could increase interest rates. This would increase cost of borrowing and reduce consumer spending and investment.

The problem with using higher interest rates is that although it will reduce inflation it could lead to a big fall in GDP.

The long term solution to cost push inflation could be better supply side policies which help to increase productivity and shift the AS curve to the right. But, these policies would take a long time to have an effect.

POLICIES TO REDUCE COST PUSH INFLATION

Inflation which arises due to various factors like rising income, exploding population, etc., leads to aggregate demand and exceeds aggregate supply, and tends to raise prices of goods and services. This is known as demand-pull or excess demand inflation

This occurs when AD increases at a faster rate than AS. Demand pull inflation will typically occur when the economy is growing faster than the long run trend rate of growth. If demand exceeds supply, firms will respond by pushing up prices.

2. DEMAND-PULL INFLATION

DIAGRAM SHOWING DEMAND-PULLINFLATION

Increases in the money supply - This is one of the main focuses of the Federal Reserve. If an economy has too much money among its citizens, they will demand more product than firms can keep up with, pulling up prices.

Increases in government spending - When the government spends large amounts of money in the private sector through purchases and contracts, this increases demand for products and creates supply issues, ultimately pulling up prices.

Foreign growth or foreign price increases - If prices are rising in other countries, foreign consumers may demand the domestic products you buy at cheaper rates. This increase in demand can result in higher prices paid by you. If other countries experience large population growth, this can result in foreign citizens demanding more products from other countries and pulling up prices, too.

CAUSES OF DEMAND-PULLINFLATION

The government could pursue deflationary fiscal policy (higher taxes, lower spending) or monetary authorities could increase interest rates. This would increase cost of borrowing and reduce consumer spending and investment.

The problem with using higher interest rates is that although it will reduce inflation it could lead to a big fall in GDP.

The long term solution to cost push inflation could be better supply side policies which help to increase productivity and shift the AS curve to the right. But, these policies would take a long time to have an effect.

POLICIES TO REDUCE DEMAND PULL INFLATION

Though inflation cannot be distinctly related to the demand pull and cost push inflation, it is important to understand them so that corrective actions can be done to mitigate inflation.

For example, where there is a greater element of demand pull, then the government needs to ensure ready supply of goods and services for example, asking producers/retailers not to halt or hoard goods respectively.

SALIENT POINTS

TYPES OF INFLATION• Inflation based on Coverage or scope:

• Comprehensive or Economy-Wide Inflation, and• Sporadic Inflation.

• Inflation based on Time of occurrence:• War-Time Inflation,• Post-War Inflation, and• Peace-Time Inflation.

• Inflation based on Government's reaction or control:• Open Inflation, and• Suppressed or Repressed Inflation.

• Inflation based on Rising prices:• Creeping, Mild or Low Inflation,• Chronic or Secular Inflation,• Walking or Trotting Inflation,• Moderate Inflation,• Running Inflation,• Galloping or Jumping Inflation, and• Hyperinflation.

Effects of inflation

Investment Interest rates Exchange rates Unemployment Stocks Decrease in the purchasing power Change the allocation of income

CONTROLLING INFLATION

There are broadly two ways of controlling inflation in an economy:

 

1). Monetary measures  

2). Fiscal measures

1. Monetary policy Credit Control Demonetization of Currency Issue of New Currency

2. Fiscal policy Reduction in Unnecessary Expenditure Increase in Taxes Increase in Savings Surplus Budgets Public Debt

3. Other Measures To Increase Production Rational Wage Policy Price Control

CONCLUSION & CONSEQUENCES OF INFLATIONAdverse effect on productionAdverse effect on distribution

of income Obstacle to developmentChanges in relative pricesAdverse effect on the B.O.P

In reality, low inflation rate and an upward economic growth is never possible. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalate.