Read this essay to learn about different causes of Inflation!
Inflation is a very complicated phenomenon and may be caused by several factors.
The following are the main causes of inflation:
(i) Demand-Pull Inflation:
Basically, inflation represents a situation whereby the pressure of aggregate demand for goods and services exceeds the available supply of output (both being counted at the prices ruling at the beginning of a period). In such a situation, the rise in price level is a natural consequence. Now this excess of aggregate demand over supply may be the result of more than one force at work. As we know, aggregate demand is the sum of consumers’ spending on current goods and services, government spending on current goods and services and net investment being contemplated by the entrepreneurs.
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At times, however, the government, the entrepreneurs or the households may attempt to secure a larger part of output than would thus accrue to them. Inflation is thus caused when aggregate demand for all purposes— consumption, investment and government expenditure — exceeds the supply of goods at current prices. This is demand-pull inflation.
(ii) Cost-Push Inflation:
We can visualize a situation, where even though there is no increase in aggregate demand, prices may still rise. This may happen if the costs, particularly the wage-costs, go on rising. Now as the level of employment rises, the demand for workers also rises so that the bargaining position of the workers becomes stronger. To exploit this situation, they may ask for an increase in wage rates, which are not justifiable on grounds either of a prior rise in productivity or of cost of living.
The employers in a situation of high demand and employment are more agreeable to concede these wage claims, because they hope to pass on these rises in costs to the consumers in the shape of rise in prices. If this happens, we have another inflationary factor at work and the inflation thus caused is called the wage-induced or cost-push inflation.
(iii) Wage-Price Spiral:
But that will not be the end of the story. A rise in prices reduces the real consumption of the wage earners. They will, therefore, press for higher money wages to compensate themselves for the higher cost of living. Now an increase in wages, if granted, will raise the cost of production further and, therefore, entrepreneurs will be tempted to raise the prices.
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This adds fuel to the inflationary fire. A further rise in prices raises the cost of living still further, and the workers ask for still higher wages. In this way, wages and prices chase each other and the process of inflationary rise in prices gathers momentum. If unchecked, this may lead to hyper-inflation, which signifies a state of affairs where wages and prices chase each other at a very quick speed. This is a state of galloping inflation.