Inflation and its Types
Inflation is defined as sustained or continuous rise in the general price level of goods and services in the economy. Inflation basically leads to increase in the cost of living leading to a fall in the standard of living of mass people. During inflation, excessive money chases too few goods in the market. Thus, during inflation, the value of money decreases that is price level arises.
There are two types of inflation, they are:
1. Demand-pull Inflation
2. Cost-pull Inflation
1. Demand-Pull Inflation:
In the inflation arises due to excess demand for goods and services over limited quantity supplied, it is called demand-pull inflation. When aggregate demand increases, the available supply cannot meet the increased demand. So, the price of goods and services will rise and demand-pull inflation occurs.
Causes of Demand-pull Inflation:
a. Increase in Population:
If there is increase in population in the nation, they demand more goods and services. Due to this, aggregate demand curve shifts toward right. It causes increase in price level and demand-pull inflation takes place.
b. Increase in public expenditure:
If the government increases the expenditure, there will be more flow of money in the economy and with the suppliers of the factors of production. Because of this, they demand more goods and services and hence demand pull inflation takes place.
c. Increase in money supply and bank credit:
If central bank supplies more money and commercial banks create more credit, it creates the purchasing power of individuals. They demand more goods and services and demand-pull inflation takes place.
d. Decrease in the rate of interest in the economy:
If the rate of interest in the economy decreases, people demand more money; they take more loan for business and other purposes. It also results demand-pull inflation.
e. Increase in circulation of illegal money:
If more illegal money is circulated in the economy, it also causes demand-pull inflation.
2. Cost-push Inflation:
Increase in general price level of goods and services in the economy due to increase in costs of production is called cost-push inflation. When prices of factors of production (rent, wage, interest, and profit) and prices of raw materials increase, cost of production also increases and then prices of goods and services go up.
Causes of Cost-push Inflation:
a. Increase in wages and salary:
If the government fixes minimum wage rate or the trade union give pressure to increase the existing wage rate, it increases the cost of production for producers which leads to cost-push inflation.
b. Increase in profit margin by the producer:
If the producer want to increase the amount of profit in the business, then they increase the profit margin on each good. So, they increase the price of all goods and cost-push inflation takes place.
c. Increase in the rate of indirect tax:
If the government increases the rate of indirect tax like custom duty, value added tax, etc., it increases the prices of imported raw materials. It also increases the cost of production for the producers and cost-push inflation takes place.
d. Shortage of basic raw materials:
The shortage of basic raw materials leads to cost-push inflation. In the period of shortage of raw materials, the suppliers increase their prices and hence cost of production increases. It results into cost-push inflation.
e. Increase in factor costs by government:
Sometimes the government may increase the prices of factors of production like wage, rate of labor, rent of houses, and capital goods, etc., which increases the prices of all the goods and services.