Question

What is the meaning of Inflation in Economics? Define.

What are the causes of Inflation  in Economics? illustrate. 

Answer 1

Meaning -

Popularly, inflation refers to a rise in price level or, which is the same thing, fall in the value of money. There are many definitions of inflation. By inflation most people understand a sustained and substantial rise in prices.

According to Crowther,

"inflation is a state in which the value of money is falling, i.e.. prices are 'rising'."

According to G. Johnson,

"we can define inflation as substantial increase in prices".

Milton Friedman writes:

"by inflation I shall mean a steady and sustained rise in prices".

Some other economists, like Coulburn, by inflation mean increase in the volume of money when they define inflation as: "too much money chasing to few goods". Increase in the volume of money is responsible for rise in prices is given expression to by several writers' "abnormal increase in the quantity of money" (T.E. Gregory), "the issue of too much money" (Hawtrey), etc. The implication in these definitions is that price rise due to an increase in the volume of money as compared to the supply of goods. This is the quantity approach to the rise in the price level.

The definition discussed above look upon inflation as a purely monetary phenomenon. But recently, the Cambridge economists, including Pigou and Keynes, have analyzed inflation as a phenomenon of full employment According to Prof. Keynes, inflation is caused by an excess of effective demand and has linked up the concept of inflation with the phenomenon of full employment According to Keynes, an inflationary rise in the price level cannot take place before the point of full employment. An expansion of money supply will not lead to a rise in the price level so long as there are unemployed resources in the economy. The price level will rise only after the point of full employment has been reached. According to Keynes, the rise in the price level after the point of full employment is true inflation. It is possible for the price level to rise even before the point of full employment if there arise certain bottlenecks in the expansion of output in the economy. But this rise in the price level cannot be termed as true inflation.

Prof. Keynes has referred to this pre-full employment inflation as semi-inflation. The rise in prices after the stage of full employment is bad for the country since there is no corresponding increase in production or employment- "inflation" is used to express such a rise in the price level. Inflation, therefore, refers to a rise in the price level after full employment has been attained.

Causes of Inflation -

The main factor responsible for inflation is generalized excess demand. The factors that cause excess demand are the factors that result in inflation. Excess demand in turn may be the result upward shift in demand or downward shift in supply.

Increase in Demand -

Monetarists as well as Keynesians believe that inflation is mainly due to factors which cause an upward shift in the aggregate demand. The main factors which came this shift are as follows:

1. Excess supply of Money: An important cause of excess monetary demand is increase in money supply. Increase in money supply leads to increase in disposable income of the people and raise the demand for goods and services.

2. Increased government expenditure: which is financed by borrowings from the central bank is another cause of inflation. Enormous increase in expenditure on development projects with long gestation periods places money income immediately in the hands of the recipients while such projects as steel plants take time to add to the nation's output. This generates inflationary pressures.

3. Deficit financing: is also a major cause of upward shift in demand. It has become a feature of fiscal policy of the developing counties. It puts money in the hands of the public at a faster pace as compared to the availability or goods and services to them.

4. Excessive credit creation by the commercial banks: especially to finance unproductive and speculative business or to finance consumer durables may contribute to rise in prices.

5. High rates of growth of population: in some of the developing economies may also contribute to inflation. Increasing urbanization of population and the powerful demonstration effect of the urban rich on the migrants from rural areas is also responsible for upward shift in demand.

6. Rising demand of home produced goods: in foreign countries induces increase in export and people in the country get export earnings. These earnings may add to excess demand. Since supply of the goods at home is reduced the prices rise.

Decrease in Supply -

Economists believe that inflation is due to the factors which cause a downward shift in the supply of goods and services. The main factors which cause decrease supply are as follows:

1. Slow Industrial Expansion: Industrial expansion is often hampered by bottle-neck such as shortage of labour, electric power, raw materials etc. In mixed economies wrong economic policies of the government may also hamper production in the private sector especially if the administration is inefficient and weak. Such structural constraints as productive inefficiency, wrong personnel policies, long 'gestation period and underutilization of existing capacity may contribute to inflationary pressure, Labour unrest may add fuel to the fire.

2. Low Agricultural Production: Agricultural production is subject to seasonal variations as it is dependent on natural factors. Food shortages and shortages of other raw materials may give rise to inflation,

3. Artificial Shortage of Goods: Atmosphere of artificial scarcity created by speculators and hoarders also contributes to inflation as they can significantly influence the expectations of the people about inflation. However, speculators and hoarders cannot cause inflation. The can only make it worse.

 

Popularly, inflation refers to a rise in price level or, which is the same thing, fall in the value of money.