Simply put, demand pull inflation is the product of mismatch between supply of goods and services and demand in the market. While Shortage of raw materials, lack of competitive market, government regulations, and natural hazards are some of the causes of cost push inflation. So, let’s see the types and causes of inflation in detail.
What are the types of inflations?
Loss of purchasing power or monetary value of given unit compare to earlier is called inflation. Means, you can’t purchase as much as you could do earlier.
In macroeconomics, demand pull inflation, cost push inflation and built in inflation are the major types of inflations. In this article, I’m explaining types and causes of inflation.
Meaning and definition of demand pull inflation
In the process of understanding types and causes of inflation, first of all let’s begin with demand pull inflation.
If the demand for given product exceeds the supply of same goods, consumers compete to get it even by more dollars. In this situation, prices of that product rise than what it should be when there is equilibrium.
Preciously, decrease in purchasing power of currency is termed as inflation. Depending on the causal factors, inflation, generally, classified as demand-pull inflation, cost-push inflation, and built-in-inflation.
Demand pull inflation is the product of mismatch between supply of goods and demand by consumers. Here, I’m going to explain the causes and impacts of demand pull inflation in detail.
A.Understanding Causes of demand pull inflation
As I mentioned before that demand pull inflation is the result of mismatch between supply of goods and demand by consumers.
Further, it may be caused by various reasons like central bank policy, sudden shortage of goods, robust economy, rising living standards, are some of the major causes of demand pull inflation.
1.Economic growth and rising living standards
Suppose, if the economic growth is healthy and robust, people have more employment and enough money in their pockets to spend. At the same time, the supply side may or may not match with the pace that demand rise.
So, result would be shortage of supply of goods with greater intent of public to purchase. Consequently, prices can exceeds normal toleranting capacity.
2. Central bank monetary policy instruments
Similarly, when central bank by the means of reduce the CRR or repo rates, it causes extra fund in the hands of public. In this way as well, prices may shoot up causing inflation.
Apart from these, government policy interventions to boost government spending on infrastructural project may cause shortfall of required commodities public required.
All the above mentioned causes push prices of goods and services up and compel public to pay more for the same things earlier they used to pay.
3.Impacts of demand pull inflation
As per the laws of demand and supply, when there is higher aggregate demand in the market for goods and services, the chances are more to rise in the prices of inputs needed to produce.
Therefore, demand pull inflation may cause cost push inflation in long run if the supply is not restored in time. It is also noticed that demand pull inflation is necessitated and facilitated by the economic growth. And, it is a unavoidable process when a nation experience healthy growth.
B.Explaining Causes of cost push inflation
There is hardly possible of equilibrium in the production and demand for the product in question. Obviously, fluctuation is part and parcel of the modern day economies.
Shortage of raw materials, lack of competitive market, government regulations, and natural hazards are some of the causes of cost push inflation.
Definition and Meaning of cost push inflation
Production can’t be free from fluctuation of prices of inputs like labor, raw materials, capital goods etc. If the input prices rises without change in the degree of demand for given product, it is termed as the cost push inflation, and consumers have to pay more than that of they used to pay earlier.
Shortfall of raw materials, lack of competitive market, government regulations, natural hazards, and currency market volatility are some of the causes of cost push inflation that I’m going to explain here.
Understanding Causes of cost push inflation
More or less causes of cost push inflation are same until and unless unexpected thing arises like COVID-19 and thereafter sudden spike in cost push inflation.
1.Rise in prices of raw materials
Period of time in which demand for given product remains unchanged but to fulfill rising demands producers have to purchase raw material and other inputs at higher prices.
In such circumstances, consumers have to pay extra dollars for the same product they used to pay earlier. Such situation remains unchanged unless there is adequate supply of raw materials restored. Or, it may prevail permanently.
2.Lack of competitive market or open economic system
If there is barriers to entry or exit in the market, it is impossible to produce goods and services at the lower opportunity cost.
Suppose, there is a single firm in the economy that determines the production and supply of specific goods or service, it is not possible to maintain the required equilibrium between supply and demand.
Hence, in the perfect competitive market, consumer decides the prices of identical product and not the single player. So, monopolistic market may cause cost push inflation.
3.Change in exchange rate or devaluation of currency
In case, if the source region of inputs is outside nation, it is expected that the currency may either appreciate or depreciate in the course of time.
So, when there is devaluation in the domestic currency, it is bound to reflect or manifest in the rise in prices, and so the inflation.
Though there are some means to hedge the risk of such fluctuation, it works for short term not long term.
4.Natural hazards or disasters
Such incidents like droughts, cyclones, floods, earthquakes, etc. may impact agricultural output and mining activities at a certain extent. And, result will definitely cause the shortfall of supply.
Relations between cost push and demand pull inflation
So far, we have learnt that there is close interlink between cost push and demand pull inflations. If there is mismatch in the demand and supply of giving product, the result would be rise in prices due to rise in demand and decline in supply.
But, the mismatch may be caused by various reasons like shortage of raw materials, liquidity, factors of production, or may be natural calamities.
Such causal factors may disturb the equilibrium of demand and supply. Consequently, cost may go up causing cost push inflation.
That’s why there are checks and balances in the economic system. There is a role of central bank to put control by exercising policy instruments after regular intervals.
C.Built-in-inflation causal factors
Built in inflation is the third form of inflation along demand pull and cost push inflations.
Built in inflation is, in real terms, product of both demand pull inflation and cost push inflation. Inflation means loss in purchasing power of consumers.
Causes of built in inflation
In the situation of high demand pull and cost push inflation, workers, labours, employees demand more wages, salaries, to compensate rise in cost of goods and services.
Such situation creates dilemma for owners. If they avoid pay hike, there may be shortage of labour and so the lesser supply of goods and services in market.
If there is shortage in supply, prices may shoot up beyond limit causing demand pull inflation.
Even though owners go for salaries and wages hike, the cost of products is going to rise as a result.
Short summary of types and causes of inflation
Inflation is the product loss of purchasing power of given amount compare to earlier.
In macroeconomics, demand pull inflation, cost push inflation and built in inflation are the major types of inflations. In this article, I’m explaining types and causes of inflation.
Demand pull inflation is the product of mismatch between supply and demand of given product or service.
There may be various reasons like robust economic growth, rise in standards of living, monetary policy, etc.
Cost push inflation is caused when the prices of inputs rises.
Such inflation is caused due to shortage of raw materials, change in exchange rate, natural calamities etc.
And, third is built in inflation. It is a product of rise in wages, and salaries of labours and workers as result of demand pull inflation and cost push inflation.
You may lose your saving. Loss of Purchasing power comparatively, rise in cost of debt, loss of currency value, are the major impacts of types and causes of inflation.
Solved questions on types and causes of inflation
As usually, to get better control on the given topic, it is necessary to take a look at the solved questions.
Q. 1 What are the types of inflations?
Ans: In layman’s terms, inflation is either loss of currency value or purchasing power of given amount.
Demand pull inflation, cost push inflation,and built-in inflation are the major types of inflations in macroeconomics.
Q. 2. What are the causes of inflation?
Ans: Actually, there is no strict line between causes of all types but there is a possibility of overlapping. Mismatch between supply and demand, shortage of raw materials, rise in standards of living, robust economy, monetary policy, government incentives, natural calamities, rise in wages and salaries are the general causes of inflation as whole.
Q. 3. What are the impacts of inflation?
Ans: Loss of Purchasing power, decrease in monetary value within country, loss of currency value in international market, decrease in value of debt, expensive debt, decline in consumption, impact on Economic growth and development are some impacts of inflation we experience.
These are the types and causes of inflation. I think I have touched each and every aspect of this issue. If you think, there is something missing, you can ask.
Elasticity and inelasticity of demand
Understanding stages of economic growth
Primary and secondary securities
Principles of money supply and inflation
Opportunity cost and comparative advantage
Actual cost and opportunity cost