Types and Causes of Inflation

Topics: Economics, Inflation, Macroeconomics Pages: 8 (2784 words) Published: December 8, 2012
Since the inception of civilization, man has been faced with the basic economic problem – scarcity! The natural habitat within which we live has a limited ability to produce and provide for the human race; whose growth is exponential. From this realization, economics was born. To this extent, Lionel Robbins defined economics as ‘‘a science which studies human behavior as a relationship between ends and scarce means which have alternative uses (Becker, 1996)’’, Cameron Rondo further defined economics as ‘‘the social science that analyzes the production, distribution, and consumption of goods and services. (Robin, 1931)’’ It is the production and distribution that is the interest here. Macro economics is the branch or field of economics that deals with aggregate economics; it analyses the economy as a whole, in terms of the national production and consumption. Thus macro economics looks at factors of production and consumption, using the scarce resources – at a national macro level. Macro Economic policy looks at four primary variables, in the study of the economy as a whole, these being unemployment rate, balance of payments, the national interest rate and inflation. This four variables are the major and primary interest of every government, because they are all related to economic growth, which is an indication of the wellbeing of people in an economy – a conceivably obvious interest too, as this determines whether or not they get re – elected! This essay will discuss the fourth variable; inflation. The Essay will look at the general concept and phenomenon of inflation, the causes of the same and the incidence of inflation in Malawi in particular. INFLATION

Historically the term inflation ‘‘referred to the increase of money supply in the economy, and some economist will still refer to it in this way. (Jevons, 2004)’’ In the modern sense, inflation is generally referred to as the general and sustained increase in the price level. An increase in the money is not inflation itself, but rather an inflation causing agent, as shall be seen later in this essay. TYPES AND CAUSES OF INFLATION

Inflation is generally categorized into two primary categories; Demand pull inflation and cost push inflation.

Demand Pull Inflation
Demand pull inflation is ‘‘the inflation that is caused when the total demand of goods and services has exceeded the supply of those goods and services. (Hicks, 1998)’’ The laws of demand and supply hence come to play here. The suppliers observe that there exists a sufficient demand for the goods and services and decide to raise their prices (and given a large enough excess demand over available supply, their goods and services will tend to exhibit inelasticity – hence a price rise will mean an increase in revenue) or the consumer noticing that there exists a larger demand than supply, will begin to outbid each other. In either case, the price of goods and services in this economy will rise, bringing about inflation. Demand pull inflation is synonymous with either economic growth or a supply shock.

Demand Pull Inflation Due to Economic Growth
When there is economic growth in the economy, people will generally tend to want to consume more out of national income (the goods and services being produced nationally). This can happen because of expansionary fiscal and monetary policy enactment by the government. Essentially, expansionary policies stimulate demand, and thus economic growth. Suppose for instance, that a government applies an expansionary monetary policy, such as lowering interest rates. This will make cause an increase in investment expenditure (as it is now cheaper to borrow money from commercial banks by the firms). As the firms invest, they will increase their capacity to produce goods and services, and in so doing will employ more people. As their profits increase they will tend to also increase the wages of their employees. This will translate into an economy whose population now...
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