Summary of inflation

DEMAND AND SUPPLY SIDE OF INFLATION

We all must have studied a lot about inflation, what it is, how it is caused, and policies to remove
inflation and so on. But here we are going to consider the various types of inflation that may prevail
in the economy. But first starting with the definition of inflation.
INFLATION?
Inflation refers to increase in the general price level of goods and services in an economy over a
period of time. Inflation is of two types: Demand side inflation and Supply side inflation.
DEMAND SIDE INFLATION
A rise in the prices which is caused due to increase in the demand for goods and services in the
economy is termed as Demand –side inflation which is also known as Demand-pull inflation.
What Demand-Pull Inflation?
When the supply of money in the economy increases, people have more money available which in
turn increases their purchasing power. As a result of which, demand for goods and services
increases. In response to rising demand, instead of increasing supply of goods and services, prices
are increased which causes reduction in demand but at the same time increase in the profits of the
sellers. In below graph you can observe that Price level of this economy has increased along with
an increase in national income. Therefore, Demand side factors increases inflation but decreases
unemployment because of an increase in national income which is the result of increase in
production level of the economy.
 Example: - A seller selling a good for Rs 2 earns profit of Rs1000 by selling 500units of that
good. Experiencing the rising demand for good, he increases its price to Rs 4, as a result the
demand falls and now he sells only 300 units of good but still witnesses an increase in profit to Rs
1200.
How to reduce demand-pull inflation?
The most effective way to reduce the demand-pull inflation is by reducing the supply of money in
the economy through monetary policy which will reduce the purchasing power of the people and
hence the demand will fall further reducing the prices of goods and services. You can observe in
the below graph that in the result of a decrease in money supply, inflation has decreased but at the
same time output level has decreased which will have raised unemployment in the economy.

Now, after getting a clear understanding of demand side of inflation or Demand-pull inflation, the
next we come up with is Supply side of inflation or Cost-push inflation.
SUPPLY SIDE OF INFLATION
The rise in the prices which is caused due to reduction in the supply of goods and services in the
economy is called supply side of inflation which is also known as Cost-Push Inflation
WHAT COST-PUSH INFLATION?
As the name suggests, when the cost of production of a good or service increases, it becomes
expensive for the producers to produce goods and services and as a result they transfer this burden
of rise in the cost of production to the customers by increasing the prices of goods and services.
Thus, causing inflation. The below graph is a representative of increase in cost of production
which leads to reduction in aggregate production and supply. Bu this time inflation and
unemployment are increasing simultaneously.

Causes of Cost-Push Inflation.

The various causes which lead to cost-push inflation are-
 Increase in the prices of raw materials
 Increase in taxes like VAT and excise duties
 Increasing the amount of wages and salaries to workers.
How to reduce Cost-Push Inflation?
 Providing better education and training to the workforce which increases the supply
 Adopting measures to carry out cost-effective production.

What is Stagflation
Stagflation is a condition of slow economic growth and relatively high unemployment, or
economic stagnation, accompanied by rising prices, or inflation. It can also be defined as inflation
and a decline in gross domestic product (GDP). Stagflation is an economic problem defined in
equal parts by its rarity and by the lack of consensus among academics on how exactly it comes to
pass. The below picture is representing the situation of stagflation where initial rise in cost of
production causes a backward shift of aggregate supply curve which causes inflation. But along
with rise in this inflation, unemployment has also increased. To enhance the level of employment
Govt. will raise money supply which again responsible for high price level.
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MAJOR CAUSE OF INFLATION!

Sometimes it happens that the policy makers misinterpret the supply side inflation which is
prevailing in the economy as demand side inflation and take measures to control it accordingly.
As we know that in demand side inflation, because of the increase in demand of the good its prices
rise and in order to control it the government, with the help of monetary policy, increases the
interest rates causing aggregate demand to fall. As a result of this action, the prices should fall, but
what happens is just the reverse reason being that the type of inflation in the economy is supply
sided in which price of good rise due to the scarcity of that good. Therefore, increasing interest
rates will not reduce the inflation in the economy rather it will further increase.