Inflation movements and factors

Use economic theory to explain the inflation movements and factors influencing it. Use relevant models to explain the impact of changes in fiscal and monetary policies in curtailing inflation.

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Introduction:

The latest survey carried out in a number of countries including India, USA etc. bring to light the fact that that inflation happens to be the most significant fear of the individuals as it unfavorably influences their living standard. This particular essay provides an insight into the concept of inflation and factors affecting it. Further, it also includes the impact of alterations in fiscal as well as monetary policies in reducing inflation.

Concept of Inflation:

To start with, the term inflation simply implies a procedure of increasing price level. A condition is termed as inflationary at the time when either the money supply or prices are increasing, but in actually both would increase collectively. As per Keynesian sense real inflation initiates at the time when the elasticity of supply of the productivity in retort to increment in the supply of money has gone down to zero or in case when output is insensitive to alterations in the supply of money. According to inflation means a climb in prices which results in the decline of the purchasing power of a country. Moreover, Inflation is considered to be a standard economic development till the time the annual percentage continues to be low, but as soon as the percentage goes up a pre-decided level, it is regarded as an inflation problem.

Moving ahead, there exist a number of factors which lead to inflation. For instance, inflation could take place at the time when government entities issue a surplus of money in order to handle a problem. Therefore, prices increment at an exceedingly rapid speed so as to carry on with the money surplus. This is termed as the demand-pull inflation wherein the prices are compelled upwards due to a large demand. Other widespread reason of inflation is an increase in manufacturing costs that result in boost in the cost of the final good. For instance, in case if raw materials amplify in cost, this results in the increase in production cost that further results in the organization incrementing prices so as to maintain sound profit levels. Moreover, increasing labor costs could also result in inflation. Since the employees demand for wage amplification, organizations generally decide to move on those costs on their clients.

In addition to this, Inflation could take place due to worldwide lending as well as national debts. Since countries borrow funds, they have to cope up with the interests, which in turn lead to rise in the price. A serious fall in the exchange rate could also lead to inflation, due to the fact that the governments would have to handle disparities within the import or export level. Apart from all this, inflation could also be brought about due to federal taxes levied on customer goods like fuel. When the taxes increase, dealers frequently shift on the load to the customers; but once costs have incremented, they hardly ever come down, even in case if the taxes are decreased afterwards. Further, wars are time and again believed to be the reason for inflation. Wars repeatedly influence everything ranging from worldwide trading to workers cost to goods demand, as a result, it at all times creates an increase in the price levels.

Cost-Push Inflation:

Cost-push inflation occurs at the time when the general cost of the products goes up due to an increase in the costs related with those products. In simple words, Cost push inflation results from incremented cost of production. Moreover, the augmented cost of production could be because of destructive trade unions wanting for superior salaries or grants, rise in the costs of domestic raw resources or imported goods or raw materials. However, because of incremented cost of production, producers have to perk up the prices of their products and services in order to balance the augmented prices in raw materials or workers, therefore, generating inflation. For instance, in a case if a new tax of 10% is issued on all the organizations, then each organization would increase its prices by 10% with the intention to regain its lost earnings. This implies that every individual who wishes to purchase something has to shell out an extra 10%. Cost push inflation implies to the situation where although there is no increment in AD (Aggregate Demand), the prices of the goods might still increase mainly because of rise in wages and price of raw materials.

The figure below highlights the concept of cost-push inflation. When cost of production increments, the aggregate supply declines from AS1 to AS2, it leads to an increment in the level of price from P1 to P2. The basis behind the increase in price is the fact that companies increase the prices of their products in order to maintain their profit margins, thus resulting in inflation.

1796_inflation1.jpg

Demand-Pull Inflation:

Demand-pull inflation is normally related to budding economies. When the income increases the demand for products also increases. However, this brings down the supply that causes manufacturers to lift up the cost of their products. Demand-Pull inflation basically highlights a condition where there is an increment in AD (Aggregate Demand) for goods either from the industrialists, government or the houses. Further, the outcome of this is the fact that the force of Demand could not be satisfied through the presently obtainable AS (Aggregate Supply) which leads to Aggregate Demand being more than Aggregate Supply. This results in increase in price of goods or services and ultimately creates inflationary pressure within the country.

Moving ahead, there exist several forces which could bring about demand-pull inflation, but all the forces are related to individuals in common being capable of generating additional money. For instance, in case if a nation’s currency loses worth in the global marketplaces, then the proceeds level from exporting products would go up. This would increment income level, which would sequentially augment demand and further result in demand pull inflation. Additionally, other factors such as extreme foreign investment, expansionary monetary policy such as increment in the supply of money, expansionary fiscal policy including an increment in the government spending, deficit financing etc. also cause demand-pull inflation.

The figure below, illustrates the concept of demand pull inflation. When AD (aggregate demand) rises from AD1 to AD2, in the short run, aggregate supply would not shift, but leads to a shift in the quantity supplied as shown by a movement on the AS curve.

An increment in the production because of incremented demand, results in the increase in the cost of manufacturing each extra output, as shown by the shift from P1 to P2. In order to maintain their profit the companies pass on the greater production cost on customers by increasing the prices of goods, resulting in inflation.

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Structural inflation:

The structural inflation occurs due to alteration in the arrangement of economies like from agricultural structure to industrial structure or any other structure. As a result, due to modification in economic structure prices increase and in turn create inflationary pressure.

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