Causes of Inflation

a) Demand-Pull Inflation

• As the economy is approaching full-employment, an excessive increase in aggregate demand will pull up prices.

• This increase in demand will put a pressure on supply and hence, create a rise in demand for factor input.

• This will force the price of factor input to increase and cause an inflationary spiral.

b) Structuralist Approach

• It can be explained by the rigidities of the economic system itself whereby aggregate supply is not responsive to an increase in aggregate demand.

• Factors that cause supply to be rigid are: -

i. Inflexibility of government policies.

ii. Immobility of factors of production.

c) Cost-Push Inflation

• This can be explained by an increase in the cost of production which exceeds productivity increase.

• To maintain real wages, trade union will further demand for a higher wage rate which will then lead to a wage price spiral.

d) Monetarist Theory

• According to the Monetarist, inflation is caused by excessive money supply which can be explained using the Quantity Theory of Money (MV=PT).

e) Imported Inflation

• Inflation may be brought into the local economy from other countries that are suffering from it, when we import their high price goods.

• Alternatively, it can be attributed to the devaluation of a country’s currency that resulted in ‘high import prices’.