• Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

The Causes of Inflation.

Extracts from this document...


The Causes of Inflation There are three major causes of inflation: 1. Demand - pull inflation 2. Cost - push inflation 3. Monetarist Theory 1. Demand - Pull Inflation This type of inflation is caused by excess aggregate demand, exceeding aggregate supply. Quite simply 'too much demand is chasing too few goods'. This can occur when the growth in aggregate demand is so strong, that aggregate supply cannot respond quickly enough - resulting in prices getting bidded-up. Thus surges in aggregate demand can ( not necessarily always ) lead to greater inflationary pressures as bottle necks in supply are caused ie supply simply cannot respond quickly enough !! Demand - pull inflation is also more likely to occur when the economy is approaching full employment, and unemployed resources are becoming more scarce ie where aggregate demand is quite strong and there is only a small negative output gap ( AD is on the inelastic section of AS ). However, this contrasts to the circumstances where AD increases and there is a lot of spare capacity. In this case it is relatively easy for businesses to find spare resources without having to bid - up prices to attract them. ...read more.


How much of an negative output gap is there ? The size of the negative output gap could be signaled by: � Low levels of unemployment ( eg on the LFS measure ) � Shortages of suitably skilled workers to fill vacancies - this is often referred to as a tightening of the labour market. � Possible pressures on wage rates due to skills shortages � Difficulty in finding suitable office space / vacant buildings. � Rising rents for office space due to shortages 2. Cost - Push Inflation This type of inflation is caused by costs rising for firms - which are in turn passed on to consumers In the form of higher prices. Very importantly, this type of inflation can occur irrespective of the state of the economy. ie AD might be fairly weak, and there could even be relatively high unemployment, cost -push inflation is still possible. A good example of this would be due to oil prices rising. Task: Using an AD and AS diagram show how an increase in oil prices can lead to inflationary pressure irrespective of the strength of AD. ...read more.


This in turn will lead to inflation. Monetarists believe that the money supply can grow steadily - without creatung inflationary pressure. However, if increases become too large, then the prices will get bidded-up. The Government's Inflation Target Remember the Government has given the Monetary Policy Committee at the Bank of England an inflation target of 2.5 % RPIX ( with an allowable + or - 1 % deviation ). The MPC are in control of interest rates, and manipulate these in order to reach the inflation target. Thus the MPC must often look at current data ( eg retail sales, unemployment figures, wage inflation, savings ratios, consumer borrowing etc ) to gauge future inflationary pressure. If inflationary pressures are building, interest rates will be increased. If there are reduced inflationary pressure - rates will fall. Task: 1. Explain how a rise in interest rates should help reduce inflationary pressure 2. Examine the implications for interest setting if the government lowered the inflation target to 1.5 % 3. Examine the implications for the wider economy of a reduced inflation target. 4. Identify 10 pieces of data that the MPC might want to consider when making its monthly interest rate decision. Edexcel AS Economics Unit 3 Inflation The Blackpool Sixth Form College (c) 2003 BN 20/1/03 ...read more.

The above preview is unformatted text

This student written piece of work is one of many that can be found in our AS and A Level Macroeconomics section.

Found what you're looking for?

  • Start learning 29% faster today
  • 150,000+ documents available
  • Just £6.99 a month

Not the one? Search for your essay title...
  • Join over 1.2 million students every month
  • Accelerate your learning by 29%
  • Unlimited access from just £6.99 per month

See related essaysSee related essays

Related AS and A Level Macroeconomics essays

  1. Peer reviewed

    How can inflation be reduced?

    5 star(s)

    In China they are doing the opposite to tightening fiscal policy (know as expansionary policy), they are exercising high government spending to try and stimulate consumption. In Britain fiscal policy plays less of a major role, this is because of political stigma and monetary policy.

  2. Peer reviewed

    Explain the possible causes of inflation

    4 star(s)

    with price rises, due to upward pressure on material and wage costs. This is as opposed to more resources available as an alternative to fuel the demand. With spare capacity, this will still take place, but to a much lesser extent as firms are confident they can compete in the market without being stretched for resources in the short run.

  1. Why does smoking lead to an external cost?

    If world prices for the UK's exports fall in comparison with the cost of the country's imports, the UK will be earning less for exports than it pays out for imports. The less demand there will be for the pound, the worse the deal becomes.

  2. Budget 2004-05 and Economic Analysis of Pakistan

    been due to both demand and supply factors resulting in an increase in the prices of wheat, wheat flour, rice, meat, edible oil and onion. POVERTY: The efforts of the last five years have started yielding positive results and this year has seen the incidence of poverty declining, enrolment in

  1. With the aid of diagrams, illustrate the causes if inflation and deflation, and by ...

    'The monetarist view of inflation, encapsulated in Milton Friedman's dictum, inflation is always and everywhere a monetary phenomenon...Inflation occurs when the growth of the money supply persistently exceeds the growth of real output' (McAleese, D., 2004, p281). This can also be shown graphically as: McAleese, D., (2004, p281)

  2. Economics - House Prices.

    If interest rates are high, then this means that building societies and banks will be giving lots of profits for borrowing their customer's money. This affects the price of a house because as the person gets more money they can in some cases be saving up for houses and therefore

  1. Unemployment and its implications

    As unemployment increases less people have a relatively high real income so consumer spending will decrease. This decrease in consumer spending, fall in demand will then cause the demand for labour to fall. This is because labour is a derived demand. Long-term unemployment has an undesirable affect on the economy.

  2. ECONOMICS PAST PAPER QUESTIONS WITH ANSWERS - price elasticity and inflation.

    Hence, supply of most goods will be inelastic. If, however, there is unemployment of resources, firms can easily raise output, and in this case, supply is elastic. 2. Availability of stocks: When suppliers are holding large stocks, supply will be elastic. This is because any increase in demand can be easily met by running down the stocks.

  • Over 160,000 pieces
    of student written work
  • Annotated by
    experienced teachers
  • Ideas and feedback to
    improve your own work