Question

Inflation is more likely to be caused by a shift in an economy’s aggregate demand rather thana shift in its aggregate supply.Discuss the given statement.

Answer 1

Inflation refers to the steady rate of increase in price levels for commodities and services in an economy in a given period.

Aggregate demand is the total quantity of goods and services demanded by buyers at different price levels in a given period of time.

Aggregate demand rises when income levels rise, as more goods and services can be bought with higher levels of income. Due to this, when demand rises for goods and services, there emerges a competition among buyers to buy the quantity of goods and services that they require and when they do not get to buy what they need, they tend to bid on higher prices in efforts to buy the quantity of goods and services that they need, thus raising market price when there is limited supply for goods and services.

At times, suppliers tend to raise price for their products when there is increased demand for the same at a given period of time. For example, Fireworks and crackers are sold at higher prices during festival seasons than at any given point of time in a year.

Thus an increase in aggregate demand , creates excess demand and raises price levels, thus inducing inflationary tendencies.

As demand increases, yet the short run aggregate supply remains more or less the same, there is excess demand and a resultant increase in price level causing an inflationary gap as seen above, Quantity demanded rises to QD and price level rises to P1, thus indicating excess demand and rising prices that causes inflation.

This is why, aggregate demand and an increase in the same causes inflationary tendencies than an increase in aggregate supply which causes excess supply and reduction in general price levels due to increased abundance in supply of goods and services.