Causes & consequences of inflation

Causes of inflation:

Demand-pull inflation: increases in the price level caused by increases in AD

This arises when AD rises faster than AS, when the economy is functioning near/at productive capacity a rise in AD is likely to push up price levels 

Cost-push inflation: increases in the price level caused by increases in costs of production 

Common causes of cost-push inflation are rises in wages or raw materials costs; increasing costs of production

Consequences of inflation:

• Fall in the value of money: as price level rises, each unit of money will buy less - the purchasing power of money falls
• Menu costs: the costs of changing prices due to inflation e.g. altering and preprinting catalogues etc (time, effort and may increase labour costs)
• Shoeleather costs: costs in terms of extra time and effort involved in reducing money holdings. During periods of inflations, households and firms need their money to be earning interest or it will be losing…