Inflation is a sustained increase in the aggregate price levels. It refers to a state of rising prices and not a state of high prices.
The types of inflation observed in an economy dependent on the rate of increase in the price levels and are as follows:
- In Creeping inflation, the price level increases at a very slow rate of 2–2.5% per annum.
- In Walking inflation, the general price level of the economy increases at the rate of 5–6% per annum.
- In Running inflation, the general price level increases faster and the rate of increase in price level is about 10% per annum. Rate becomes a double digit figure.
- In Hyperinflation, the general price level increases at the rate of 200% or more per month. Here, the price rise is ten or even a hundred-fold in a month.
Demand Pull Inflation
Demand-pull inflation refers to the inflation generated by the pressure of excessive demand in an economy. If there is an excess of aggregate demand in the economy over aggregate supply, the general price level will tend to increase, which leads to inflation.
Factors which cause demand-pull inflation
- Population pressure: Heavy population pressure led to an increase in the demand for food items and other essential goods in the Indian market. This excess demand condition in the product market led to a price rise and it is termed demand-pull inflation.
- Growing government expenditure: A continuous increase in the government expenditure on infrastructural development and other developmental plans is essential. This generates more employment and income opportunities. It means additional purchasing power for the public to demand more goods and services.
- Growing supply of money: Increasing government expenditure and the credit policy of the government lead to an increase in flow of money within the economy. This in turn leads to an increase in demand for goods and services within the economy.
An increase in the general price level of an economy with an increase in the average cost of production is called cost-push inflation. Cost-push factors are an increase in the wage rate and an increase in the prices of raw materials. Producers increase the prices of goods and services to maintain the profit rates after an increase in the cost of production.
Factors responsible for the causes of cost-push inflation
- Rise in wages: Rise in wages is considered a determinant of cost push inflation. Because of trade unions, workers have organized strongly to get higher wages. This rise in wage cost may lead to the imposition of higher product price by producers. Hence, when the average prices of different consumption goods increase, workers would again demand for higher wages.
- Increase in the price of basic materials: Basic materials such as steel, chemicals and oil are used directly or indirectly in major industries. Thereby any increase in the prices of these basic materials affects the entire economy and the prices tend to increase.
- Higher taxes: Increase in taxes such as excise duties, sales tax and value added tax, where taxpayers can easily shift the burden of tax to the others, leads to an increase in the prices of different commodities.
Meaning and Functions of Money