Inflation
What Is Inflation?
Inflation is a gradual loss of purchasing power reflected in a broad rise in prices for goods
and services over time.
Inflation is a general and ongoing rise in the level of prices in an entire economy. Inflation
does not refer to a change in relative prices. price increases in the supply-and-demand
model were one-time events, representing a shift from a previous equilibrium to a new one.
Inflation implies an ongoing rise in prices. If inflation happened for one year and then
stopped, then it would not be inflation any more.
An increase in the money supply is the root of inflation, though this can play out through
different economic mechanisms. The monetary authorities can increase a country’s money
supply by:
a) Printing and giving away more money to citizens
b) Legally devaluing (reducing the value of) the legal tender currency
c) Loaning new money into existence as reserve account credits through the banking
system by purchasing government bonds from banks on the secondary market
Types of inflation
What Is Demand-Pull Inflation?
• Demand-pull inflation is the upward pressure on prices that
follows a shortage in supply. Economists describe it as "too
many dollars chasing too few goods."
• Demand-pull inflation is a tenet of Keynesian economics
that describes the effects of an imbalance in aggregate
supply and demand. When the aggregate demand in an
economy strongly outweighs the aggregate supply, prices go
up.
This is the most common cause of inflation.
Demand pull
inflation
According to Keynesians, aggregate
demand may rise due to a rise in
consumer demand or investment
demand or government expenditure or
net exports or the combination of
these four components of aggreate
demand. Given full employment, such
increase in aggregate demand leads to
an upward pressure in prices. Such a
situation is called DPI.
However, how much price level will rise
following an increase in aggregate
demand depends on the slope of the
AS curve.
The essence of this type of inflation
is that “too much spending chasing too
few goods.”
Demand pull
additional inflation
demand
Increased Increase in
income price level
Cost-Push Inflation
• Cost-push inflation occurs when we experience rising
prices due to higher costs of production and higher costs of
raw materials. Cost-push inflation is determined by supply-
side factors, such as higher wages and higher oil prices.
• Cost-push inflation is different to demand-pull inflation
which occurs when aggregate demand grows faster than
aggregate supply.
• Cost-push inflation can lead to lower economic growth and
often causes a fall in living standards, though it often proves
to be temporary.
Cost-Push Inflation
AS is the initial aggregate supply curve.
1
Below the full employment stage this AS
curve is positive sloping and at full
employment stage it becomes perfectly
inelastic.
Intersection point (E ) of AD and AS curves
1 1 1
determine the price level (OP ). Now there is
1
a leftward shift of aggregate supply curve to
AS . With no change in aggregate demand,
2
this causes price level to rise to OP and
2
output to fall to OY . With the reduction in
2
output, employment in the economy declines
or unemployment rises. Further shift in AS
curve to AS results in a higher price level (OP )
3 3
and a lower volume of aggregate output (OY ). 3
Thus, CPI may arise even below the full
employment (Y ) stage.
F
Causes of demand pull inflation
• Increase in disposable income
• Increase in money supply and bank credit
• Increase in export earning
• Decrease in import
• Increase in population
• Increase in speculative hoarding
• Increase in govt. expenditure
• Increase in foreign demand for domestic good
• Money earned by illegal activities
Causes of cost push inflation
• Increase the price of raw materials
• Increase in wage rate
• Higher taxes
• Inefficiency, corruption, mismanagement of the economy
• Expectations of increasing price level
• A fall in the exchange rate
How is Inflation Measured?
It can be measured through the following indexes:
Consumer Price Index (CPI): It is the average change in prices of the goods
and/ or services over time that the consumer pays for a basket of goods
and/ or services.
CPI = (Cost of basket divided by Cost of basket in the base year) multiplied
by 100
Wholesale Price Index (WPI): It measures the changes in the prices of goods
sold and traded in bulk by wholesale businesses to other businesses.
Formula: WPI=(WPI of end of the year – WPI of the beginning of the
year)/WPI of the beginning of year x 100
Recent Trends of Inflation in Bangladesh
Methods to control inflation
Monetary
policy
Fiscal policy
Physical or
non monetary
policy
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