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’.
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