Students / Subjects

Handbook >> Inflation >>

Causes of Inflation

There are many factors that can trigger inflationary pressure in an economy. The most important of these are:

Demand-Pull Inflation - The most important factor that certainly raises the price level is the rising quantity of money that is not accompanied by a proportionate increase in output. Increasing quantity of money in the hands of the people increases the aggregate demand for goods and services and if aggregate supply doesn't follow suit prices rise. This is a reflection of classic Demand and Supply Analysis where an increase in demand results in an increase in price.  Hence demand-pull inflation: a rise in general prices caused by increasing aggregate demand for goods and services.

In other words, people have more money to buy things, but there aren't enough of the things people want to buy. Therefore, according to the predictions of the Supply and Demand model, this will cause an increase in the price of the goods suffering a shortage. This is due to the scarcity of the goods relative to the increase in the amount of money in the hands of consumers who wish to purchase them (demand exceeds supply --> shortage --> an increase in price)

Cost-Push Inflation - There are also supply-side factors that may trigger inflation. For example, if prices of some key inputs like oil rise, producers will have to either adjust output supply or translate the higher costs into higher output prices. When output declines because of cost pressure on producers there will be a shortage in output markets and prices will rise as a result, ceteris paribus, meaning all else constant. This is called cost-push inflation. Prices may also rise as a result of uncertainty about future market conditions.

Back to Inflation
