Meaning and Causes of Inflation

Inflation is the pace at which a currency's value declines and as a result, the general level of costs for goods and services rises. Although the price fluctuations of individual goods can easily be calculated over time human interests reach well beyond one or two such products. To live a comfortable life, individuals need a wide and diversified range of goods as well as a host of services. They include goods such as food grains, metal and fuel, electricity and transportation utilities, and services such as healthcare, entertainment, and labour.

Inflation attempts to calculate the aggregate effect of price increases on a diversified range of products and services and enables the rise in the price level of goods and services in an economy to be measured at a single value over a while. Prices increase as a currency loses value, and it buys fewer goods and services. The general cost of living for the general population is influenced by this loss of buying power, which inevitably leads to a deceleration of economic development.

Causes of Inflation:

In an economy, different factors can push prices or inflation. Inflation usually results from an increase in the cost of production or a rise in demand for goods and services.

Cost-Push Inflation:

Cost-push inflation happens when prices, such as raw materials and wages rise because of rises in production costs. Demand for products remains constant, although the supply of goods decreases as a result of higher production costs. As a consequence, in the form of higher prices for finished products, the additional costs of production are passed on to customers. As they are big manufacturing inputs, one of the indicators of potential cost-push inflation can be seen in rising commodity prices such as oil and metals.

For instance, if the price of copper increases, businesses that produce their products using copper may raise the prices of their goods. If the demand for the commodity is independent of the demand for copper, the higher cost of raw materials would be passed on to customers by the enterprise. Without any change in demand for the goods purchased, the effect is higher prices for customers. Prices can also be pushed higher by natural disasters. For instance, if a hurricane kills a crop such as maize, as maize is used in many goods, prices will increase in the economy.

Cost-Push Inflation Examples

Most commonly cost-push inflation occurs in the sectors of natural gas and oil prices. Gasoline and natural gas are used by almost everyone to fuel their automobiles or heat their home. Crude oil is used in refineries for the manufacturing of gasoline and other fuels. High levels of natural gas are also used by electric power suppliers for the manufacturing of electricity. The reduction in the supply of oil due to change in global policies, creation of warlike conditions or occurrence of natural disasters. These reductions in the supply of oil will ultimately increase the price of gasoline. In this case, the demand for the product remains the same but the raw material available for manufacturing the product is not available due to which the price of the product increases.

Demand-Pull Inflation:

Demand-pull inflation can be exacerbated by high demand from customers for a product or service. Prices rise as there is an increase in demand for commodities throughout an economy, and demand-pull inflation is the result. When unemployment is low, consumer morale appears to be high and wages rise, leading to more spending. Economic expansion has a direct effect on an economy's level of consumer spending, which can contribute to a strong demand for goods and services. As the demand for a specific product or service rises, the supply available decreases. When fewer goods are available, customers are willing to pay more to get the item, as illustrated in the supply and demand economic theory. Owing to demand-pull inflation, the consequence is higher prices.

Companies, especially if they produce common goods, often play a role in inflation. A business can boost prices simply because the additional amount is willing to be charged by customers. Corporations often openly increase prices because the commodity for sale is something that customers, such as oil and gas, require for daily life. Nevertheless, it is customer demand that gives businesses the power to boost costs.

Demand-Pull Inflation Example

The most recent example of demand-pull inflation was seen during the coronavirus pandemic when the global economy was completely shut down in March 2020. The global economy moved towards recovery when the availability of vaccines increased and the pace of vaccination also increased exponentially. This recovery of the global economy is increasing the demand for goods and services which were otherwise not available for the complete year. The increased demand of such products like food, household items and fuel lead to an increase in the prices of the product. The rise in the rate of employment post COVID has also led to rise in the prices of fuel, air tickets and hotel rooms. The low interest rate on properties have also made people buy new houses which has led to an increased demand for copper. Thus, as the global economy has opened up, customers are in favour of spending money but the factories don't have enough raw material to supply the products at a rate at which the demand of the product is increasing.

Effects of Inflation:

• A Decrease in Purchasing Power: The first effect of inflation is just another way of stating what it is. Inflation is a decrease in the currency's purchasing power due to an economy-wide increase in prices. The average price of a cup of coffee in living memory was one dime.

• Encouraging Spending, Investing: Buying now rather than later, is a predictable response to declining purchasing power. Cash will only lose value, so it is better to get your shopping out of the way and stock up on things that are not likely to lose value.

• Raises the Cost of Borrowing: Companies and individuals can borrow cheaply to start a business, earn a degree, hire new workers, or buy a shiny new boat if interest rates are low. In other words, spending and investment are encouraged by low rates, which in turn generally stoke inflation.

• Reduces Unemployment: There is some evidence that unemployment can be driven down by inflation. Wages tend to be sticky, which means that in reaction to economic changes, they adjust slowly.

• Increases Growth: Inflation discourages saving unless there is an attentive central bank on hand to drive up interest rates because the buying power of deposits erodes over time. The prospect provides an opportunity for customers and companies to spend or invest.

• Weakens of Strengthen Currency: A slumping exchange rate is generally associated with high inflation, but this is usually a case of the weakened currency contributing to inflation, not the other way around.

Remedies of Inflation:

There are three ways by which Inflation can be controlled:

• Monetary Policy: which is controlled by the Central Bank Of the country

1. Operation of Open Market: Inflation requires the Central Bank to reduce the cash.

2. Interest Rate: During the time of Inflation, the interest rate should be increased. An increase in Interest Rate will result in discouragement of consumption and investment.

• Fiscal Policy: Which is controlled by the government via instruments, taxes and expenditure of the government.

• Direct/Physical Control: 

1. Price Pegging: The government will decide the floor and ceiling price so that values will not increase rapidly.

2. Encourage Saving: The government raises the contribution to the employee’s Provident Funds.

3. Price Tagging: Every product needs to be labelled to prevent producers from charging to consumers.