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. 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. After Knowing the meaning of Inflation you will want to know What Causes Inflation.
Factors which Cause 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.
On the other hand, Producers increase the prices of goods and services to maintain the profit rates after an increase
in the cost of production, which leads to inflation.
Now the question is how to control Inflation.
When excess demand is caused by the government expenditure more than real output, the most effective measure is to cut down on public expenditure. A cut in public expenditure reduces not only the government’s demand for goods and services but also private consumption expenditure. Therefore, the excess demand decreases more than a given cut in public expenditure.
While controlling inflation, the Central Bank raises the CRR which reduces the lending capacity of commercial banks. Consequently, the flow of money from commercial banks to the public decreases. In the process, it halts the rise in prices to the extent it is caused by bank credits to the public.