Inflation, demand pull Inflation , Cost Push Inflation ,Wage spiral inflation ,monetarist view of inflation

 

Inflation:

• Inflation is sustained rise in the general level of prices for goods and services.
• Inflation means that the purchasing power of currency is falling.
• In India, it is calculated as an annual percentage increase in comparison to the previous year. 

REASONS FOR INFLATION:

As per Keynesian school, Inflation can be of following types :

1. Cost Push Inflation 
2. Demand-pull inflation
3. Built In Inflation /Wage-Price  Spiral

Cost Push Inflation:

• General increases in the cost of the factors of production result in increase in production cost. 
• This increase in the cost is ultimately passed on to the consumers resulting in the Cost Push Inflation.
• Ex. The sharp rise in the price of imported oil during the 1970s provides a typical example of cost-push inflation. Now a days, rising energy prices caused the cost of producing and transporting goods to rise.

Demand-pull inflation:

• It results from an excess of aggregate demand relative to aggregate supply. 
• When aggregate demand exceeds aggregate supply, prices will increase economy wide as supply can not fulfill the aggregate demand in the economy.
• Example: The sharp rise in the prices of hand sanitisers ,masks and certain type of medicine during the  covid.

Understanding cost push vs demand pull :

If your favorite chaiwala  raising prices due to the climbing cost of sugar and milk, you’re a victim of cost-push inflation.

                                                                                But 

If you’re going to buy that tea even though the price is uncomfortably high, you’re creating demand-pull inflation.

Built In Inflation /Wage-Price Spiral: 

In case of demand-pull inflation and cost-push inflation, employees may demand more costs/wages to sustain their living cost. If employers don’t keep their wages competitive, they could end up with a labor shortage. Their increased wages result in higher cost of goods and services as employer has to factor in increased wages in the prices of goods . This increase in price of goods because of rise in wages is built-in inflation/wage-price spiral inflation.

MONETARIST VIEW OF INFLATION:

"Inflation is always and everywhere a monetary phenomenon.”------Friedman

• Monetarists explained inflation as a consequence of an expanding money supply. 
• In view of the Monetarists, the inflation has little to do with the factors like labor, materials costs, or consumer demand. Rather, it is all about the supply of money.
• Monetarists theory is based upon quantity theory of money, which states that:

Money supply and inflation is governed by the relationship M x V = Px T. where,

 M = the money supply,

V = the velocity of money 

 P = average price level, and

T = Output in the economy or the volume of transactions occurring in the economy.

Monetarists believe that in the short-term:

• V ie velocity of money (money changing hands) is fixed as the rate at which money circulates is determined by institutional factors, e.g. how often workers are paid does not change very much. 
• Output T is also assumed to be fixed as it does not changes in short term.
• So, an increase (or decrease) in the supply of money will cause a corresponding increase (or decrease) in the average price level. 

So inflation proceeds at the same rate at which the money supply expands. 

From another perspective, when the money supply increases it creates more demand for goods but the supply of goods cannot be increased due to the full exploitation of resources. This mismatch of demand and supply leads to rise in prices.