Inflation

An analysis of the causes and effects of demand pull and cost push inflation

?
  • Created by: George
  • Created on: 22-09-13 18:31

Inflation

Causes

  • Increasing capital and labour costs for businesses thus forcing them to raise prices in order to maintain profitability - Cost Push Inflation
  • Increasing consumer spending power as a result of increased incomes, loan accessibility, or reduction in government taxation, thus increasing the ability of a consumer to purchase goods and services hence causing aggregate demand (AD) to rise faster that aggregate supply (AS) can increase to meet the demand - Demand Pull Inflation
  • Reduction in output due to a limited amount of a good or service hence restricting supply, hence allowing AD to increase substantially over supply.
  • Monetary inflation can occur when the government prints too much money hence reducing the value of money hence therefore causing businesses to increase prices in order to protect their capital investment thus increasing profitability to offset decreased asset value.
  • Monetary Inflation can also cause people to rapidly increase their spending power hence demanding a wider range of goods hence contributing towards cost-push inflation.

Effects

  • Depression of savings value which can be detrimental in older savers who will rely on these savings to support themselves later in life, thus reducing financial security
  • Workers demand higher wages in order to compensate for their reduced capability as their wage cannot buy as much thus therefore creating pressure on companies hence leading to wage spiral inflation in which workers demand higher wages, which increases AD thus causing demand pull inflation. This therefore causes workers to demand higher wages, hence increasing the cost of production for firms hence increasing the pressure on prices
  • Increased unemployment due to a reduction in competitiveness of a company due to higher costs hence causing a lower AD thus causing unemployment to reduce the higher costs of production
  • A deficit on the balance of payments as people import goods that are lower in price and domestic companies fail to export due to their increasing abroad
  • Banks refuse to loan due to increased inflation threatening the amount they receive back in interest.

Overall summary

Inflation therefore undercuts the governments key economic objectives which therefore causes the government to lack control. However, governments aim to maintain a rate of inflation of 1-3% in order to avoid deflation which can be more damaging due to the industrial collapse as people abstain from products in the hope their price will fall causing less consumer demand hence creating industries to fail. This is why governments aim for a slight rate of inflation to ensure a degree of safety when managing the economy.

Comments

No comments have yet been made

Similar Economics resources:

See all Economics resources »See all Managing the Economy resources »