QUESTION: What is Inflation? Also discuss the types of Inflation. (8 marks/ 120 words)
Inflation can be defined as a persistent rise in the general price of goods and services of common or daily use — such as clothing, food, fuel, transport, etc — which results in an increase in the cost of living.
Inflation is the measure of change in average price of services and commodities, done at regular intervals. It indicates a decrease in the purchasing power of a unit of a nation’s currency as the products and services get more expensive. Basically, inflation is the difference between aggregate demand and aggregate supply of goods and services. When aggregate demand exceeds the supply of goods at current prices, there is a rise in the price level.
A certain level of inflation is required in the economy to ensure that expenditure is promoted and money hoarding through savings is discouraged.
Three Types of Inflation
Inflation is classified into three types; Demand-Pull inflation, Cost-Push inflation, and Built-In inflation.
Demand-pull inflation is a situation where consumer demand for goods and services in an economy persistently exceeds the available supply when the economy is near or at full employment.
This results in a demand-supply gap with higher demand and a shortage in supply, causing prices to go up.
Demand-pull inflation is caused by excess demand, which can originate from high exports, strong investment, a rise in money supply, or government financing its spending by borrowing.
Cost-push inflation is a result of the increase in the overall prices of production process inputs.
For example, an increase in the cost of labour and/or raw material will lead to higher overall production costs.
If the cost of making a product increase, then to stay profitable, businesses need to increase their prices accordingly.
Sometimes, companies may even seize the opportunity to grow their profit margins.
The more price inelastic the demand for their goods, the less likely such behaviour will lead to a fall in demand for their products.
Built-in inflation occurs as the price of goods and services increases along with the demand for higher wages in order to maintain the cost of living.
Any upsurge in the labour wages would then result in the basket of goods and services getting more expensive, triggering a cost-pull inflation.
This wage-price spiral goes on as increases in one lead to increases in the other, and so on.
We can also categorise inflation by how fast the price increases are, such as:
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