Inflation is caused by a variety of causes such as increase in wages, increase in the price of raw materials, increase in taxes, decline in productivity, supply chain disruptions, rising fuel prices, increase in money supply etc.
The main causes of inflation can be grouped into three broad categories viz. Demand-pull inflation, Cost-push inflation, and Built-in –Inflation.
- Demand-pull inflation:
When the consumer demand exceeds relative to the supply of goods and services available within an economy that would lead to scarcity, and ultimately drive up prices. Inflation that occurs due to the scarcity of goods and services is known as Demand-pull inflation. The demand may increase due to increased household incomes, which leads to greater consumer purchasing power. More spending by businesses or the government may increase the demand. An increase in net exports may also reduce the domestic supply resulting in heightened demand. As a result, demand for goods and services will increase relative to their supply, providing scope for firms to increase prices. When it happens across a large number of businesses and sectors, this leads to an increase in inflation.
2. Cost-push inflation:
Cost-push inflation arises when the cost of producing products and services rises, due to increased expenses for raw materials, wages, or other inputs. This would force the businesses to raise the prices of their offerings. The higher production cost is transferred to consumers in the form of higher prices for goods and services. External factors, such as supply chain disruptions or geopolitical events, can also contribute to this type of inflation.
- Built-in -inflation
Built-in inflation is also referred to as wage-price inflation. It occurs when an economy enters a self-perpetuating cycle of wage hikes followed by corresponding price increases. As workers demand higher wages to counter rising living expenses, businesses react by raising prices to accommodate greater labour costs. This ultimately leads to price escalations, fostering a cycle of inflation.
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Impact of inflation on the economy
