INFLATION AND

TYPES OF INFLATION

1
 Inflation
• Definition:
– Is a steady an upward
movement in the level of
prices decreasing
purchasing power over a
period of time, usually
one year.

2
 Demand Pull Inflation
• Demand Pull Inflation occurs when Aggregate
demand (C+I+G+(X-M)) increases at a rate
faster than the capacity of the economy to
produce goods and services ie: AD>AS. This
increase competition for goods and services
drives up their prices.

3
 Demand Pull Inflation
Price $

Aggregate Supply

P2
Aggregate Demand 2

P1
Aggregate Demand 1

4
Q1 Q2 Real GDP ($)
 Demand Pull Inflation
• An increase in demand shifts the aggregate
demand curve to the right, from AD1 to AD2
pushing up the price level from P1 to P2.

5
Demand pull inflation occurs due to some
factors. Such as
• increase in money supply (expansionary
monetary policy)
• increase in government purchases
(expansionary fiscal policy)
• increase in exports

6
 Cost Push Inflation
• Cost Push Inflation occurs when prices are
pushed up by rising costs to producers who
compete with each other for increasingly scarce
resources. The increased costs are passed onto
consumers.

7
 Cost Push Inflation
Price $
Aggregate Supply 2

Aggregate Supply 1

P2

P1 Aggregate Demand

8
Q2 Q1 Real GDP ($)
 Cost Push Inflation
• An increase in the prices of inputs shifts the
aggregate Supply Curve to the left, from AS1
to AS2 pushing up the price level from P1 to
P2.

9
 Creeping or mild inflation
• Creeping or mild inflation is when prices rise 3%
a year or less. According to the Federal Reserve,
when prices increase 2% or less, it benefits
economic growth. This kind of
mild inflation makes consumers expect that
prices will keep going up. That boosts demand.
Consumers buy now to beat higher future prices.
That's how mild inflation drives economic
expansion. For that reason, the Fed sets 2% as its
target inflation rate. 10
 Walking Inflation

• This strong, or destructive, inflation is between

3-10% a year. It is harmful to the economy
because it heats-up economic growth too fast.
People start to buy more than they need to
avoid tomorrow's much higher prices. This
increased buying drives demand even
further so that suppliers can't keep up. More
important, neither can wages. As a result, 
common goods and services are priced out of
the reach of most people.
11
 Galloping Inflation

• When inflation rises to 10% or more, it causes

absolute havoc on the economy. Money loses
value so fast that business and employee
income can't keep up with costs and prices.
Foreign investors avoid the country, depriving
it of needed capital. The economy becomes
unstable, and government leaders lose
credibility. Galloping inflation must be
prevented at all costs.
12
 Stagflation
• In economics, stagflation is a situation in which
the inflation rate is high, the economic growth
rate slows down and unemployment remains
steadily high.
• Stagflation occurs when the economy isn’t
growing but prices are which is not good
situation for a country.
• Stagflation is a period of rising inflation and
falling output, unemployment will tend to be
rising.
 Hyperinflation
• In economics, hyperinflation occurs when a
country experiences very high and usually
accelerating inflation. Extremely rapid or out of
control inflation.
• Hyperinflation occurs when there is a continuing
(and often accelerating) rapid increase in the
amount of money that is not supported by a
corresponding growth in the output of goods and
services.
 Inflationary Gap
• An Inflationary Gap, in economics, is the amount
by which the real Gross Domestic Product or
real GDP, exceeds potential GDP
• On the other hand, the potential GDP is the
quantity of real GDP when a country’s economy
is at full-employment. It is one type of output
gap, the other being recessionary gap.
• The concept of inflationary gap was first given by
John Maynard Keynes in his work “How to Pay
for War”
• Inflationary gap occurs when aggregate
demand (AD) exceeds aggregate supply
(AS) at full-employment level of output. In
this case, money income rises to a higher
equilibrium, but real income (being at full-
employment output level) remains
unchanged.
 Deflationary Gap
• The difference between full-employment level of
output and actual output. For example, in a
recession, the deflationary gap may be quite
substantial, indicative of the high rates of
unemployment and underused resources.
• Deflationary gap prevails when aggregate
demand (AD) is less than aggregate supply (AS)
at full employment level of output. In this case,
income equilibrium occurs while some resources
are idle.