inflation theory economics

Since this inflation is due to the forces of cost and supply, it is not subject to easy treatment because fiscal and monetary measures may cure a cost inflation only at the expense of increasing unemployment and slower growth. They have provided two types of theories to explain the causes of inflation, which are shown in Figure-4: Let us study the different types of structural theories of inflation (as shown in Figure-4) in detail in the next sections. The relative stability of the velocity of circulation is attributed by them to the facility with which the supply of money accommodates itself to demand; they argue that insofar as supply may be restricted in the face of rising demand, velocity will increase, or (what really amounts to the same thing) new sources of credit, such as trade credit, will be exploited. Many economists believe, however, that the approach has led to better control over short-term changes in employment and real income. The adjacent Figures show cases of mixed inflation. The latter, in turn, he supposed to be negatively related, up to a point, to the stocks of “idle” money in existence—in effect, positively related to the velocity of circulation of money. Though the theory of cost-push inflation does tell us that in order to reduce unemployment a slowly rising price level is better than slowly sagging price level. Since inflation is due to excess demand, it is considered controllable by the demand reducing monetary and fiscal policies. Share Your PPT File, Measures for Controlling Inflation (With Diagram), Public Sector Enterprises or Undertakings in India. Lerner’s “low full employment” with substantial voluntary unemployment, and the last to his “high full employment” with little or none. In other words, inflationary pressures originate with supply rather than demand and spread throughout the economy. The region between low and high full employment was called by Keynes “semi-inflation” in contrast to the true or full inflation. Historically, a great deal of economic literature was concerned with the question of what causes inflation and what effect it has. Any higher nominal interest rate means that currency pays a poorer return than bonds. Share Your PDF File Omissions? Consider the adjacent Figure 32.8. Fig. In this Figure general equilibrium prevails at Y0, i0 and p0. However, he believed that wage push or market-power theories alone are not able to provide a clear explanation of inflation. Monetary policy can reduce the rate of inflation by raising the interest rate and regulating the credit flow in the market. 32.6. This website includes study notes, research papers, essays, articles and other allied information submitted by visitors like YOU. Each increase in money wage rate leads to a higher price level, lower output and higher unemployment. The correlations observed by this so-called Chicago school between money supply and money income are attributed by their critics to variations in the demand for money to spend, which elicit partial responses from supply and are followed after an interval by corresponding changes in money income. This theory maintains that prices instead of being pulled-up by excess demand are also pushed-up as a result of a rise in the cost of production. It is caused by the monopoly elements either in the labour market when there is wage-push or in the commodities market when there is profit-push but mostly it is due to wage-push which increases the cost of production and hence prices. Thus, ultimately money supply is the causal factor. On the other the goods are sold to businesses instead of customers, then the cost of production increases. The economists who have provided the theories of inflation are broadly categorized into two labels, namely, monetarists and structuralists. The Figure 32.7 illustrates the pure cost-push inflation phenomenon: Figure 32.7 shows that according to pure supply (cost-push) inflation theorists—in societies of oligopolies, unions and other pressure groups the aggregate supply curve moves upwards from S0 to .S1to S2 whatever may happen to aggregate demand. Apart from this, some economists concluded that fiscal and monetary policies are not applicable in practical situations as these policies are not able to control rise in prices levels. Different economists have presented different theories on inflation. Let us suppose that the full-employment level of output remains fixed at Y0., The Library of Economics and Liberty - Inflation, inflation - Student Encyclopedia (Ages 11 and up). Moreover, these policies cannot be applied to oligopolistic rise in prices, which is due to increase in the cost of production. Bottle-neck inflation was introduced by Prof Otto Eckstein. At this point there are no more speculative balances to be had, attempts to borrow funds either will be frustrated or, because of the resultant increase in interest rates, will cause the abandonment of other ventures. As a result of this excess demand, prices will rise and excess demand inflation or demand-pull inflation comes to exist. TOS4. Consequently, the cost and price both increases. Another variant of cost-push inflation is administrative inflation, which can occur during recession, recovery or shortages or simultaneously with demand-pull inflation. Consider the diagram 32.6, which analyses the working of excess demand inflation irrespective of the fact whether excess demand is caused by increased money supply or by expenditures on C and I. The ratio of the stock of money that people want to hold to the value of the transactions they perform each year (or the inverse of this ratio, called the velocity of circulation) is supposed, in the simplest version of this view, to be fixed by such factors as the frequency of wage payments, the structure of the economy, and saving and shopping habits. Our editors will review what you’ve submitted and determine whether to revise the article. According to classicals, the key factor is the money supply because in accordance with the quantity theory of money only an increase in the money supply is capable of raising the general price level. The rise in wages and costs leading to rise in prices (wage-price spiral) will come to an end.

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