Causes of Inflation

Demand-pull inflation

(Tutor2u, 2013)

  The Short-run Aggregate Supply(SRAS) which moves upwards  from the left to the right shows that the national output of the sector’s firm increases as the general price level increases. However, the Long-run Aggregate Supply(LRAS )reaches a state of a vertical shape once the economy has achieved full employment.  Although the price increases, the national output is constant as the allocation of the factors of production is restricted.( Lai, 2013)

  Due to the rise in consumer demand, rise in the expenditures of the government, rise in firm’s investment or an increase for the people’s demand for the country’s export, the Aggregate Demand(AD) curve will shift to the right from AD1 to AD 2. (Vengedasalam and Madhavan, 2011)

  The intersection  of AD2 and LRAS determines the full employment aggregate output which is Y2. AD2 which exceeds the aggregate supply(AS) causes demand-pull inflation. In Keynes’s analysis, it is assumed that at full employment, aggregate demand exceeds aggregate supply. If the factors of productions are fully employed or utilized, the economy is trying to produce beyond its limit. Consequently, the price level is pulled upward due to the spending. The essence of demand-pull inflation is  that there is “too much money chasing too few goods”. (Vengedasalam and Madhavan, 2011)

Cost-Push inflation

Cost-push inflation is an increase in the level of general price which is related with an increase in production’s cost.  (Vengedasalam and Madhavan, 2011).The rise in price is the rise of per-unit production cost.( McConnel,Brue and Flynn, 2012) There are several factors which cause the shift of the Aggregate Supply(AS) curve:

(i)                  Profit-push inflation

If certain monopolists or producers push up prices by stocking up goods and creating an artificial shortage.(Vengedasalam and Madhavan, 2011)

(ii)                 Import-push inflation

Because of the hike of the rate of foreign exchange, there will be an increase of the prices of imported finished or raw materials. This will lead to an increase in costs of production. Consequently, there will be an increase in the price of outputs. (Vengedasalam and Madhavan, 2011)

(iii)               Wage-push inflation

The increase in the price of output and the production’s cost will result in the wage level and eventually will lead to wage-push inflation. (Vengedasalam and Madhavan, 2011)

(Economics HELP, n.d.)

  In the figure above,  the intersection of the Aggregate Demand curve(AD2) and the Short-run Aggregate Supply Curve(SRAS1) determines the equilibrium price which is P1 and the full employment aggregate output, which is Y1.Due to the shift in upwards of the Aggregate Supply curve from SRAS 1 to SRAS 2, the equilibrium price level rises from P1 to P2 while the aggregate output falls from Y1 to Y2. Cost-push inflation is the increase in the general price level. (Vengedasalam and Madhavan, 2011)