Question

Explain the two types of inflation and what causes each one.

Answer 1

Inflation is a situation where price level of goods and services rises or purchasing power of currency falls.

Two types of inflation are: a) demand-pull inflation and b) cost-push inflation.

Demand pull inflation, is rise is price level of goods and services caused by increase in aggregate demand in an economy.
When demand of goods and services rises and supply remains constant, then aggregate demand would be more than aggregate supply. this cause rise in price level of goods and services.
Major cause of increase in aggregate demand includes increase in money supply, expansionary monetary policy results in increase in money supply and that causes increase in capacity to spend of people.
Tax cuts by government also increase the demand of goods and services as now people would have more money to spend.
Increase in government spendings also leads to increase in aggregate demand and inflation.

b) cost-push inflation is type of inflation that accur when cost of supply increases and it decreases the level of supply. When cost of production rises, it discourage manufacturers to produce goods and services, hence it effect aggregate supply in economy.
Cost of supply rises due to rise in wages, scarcity of resources, increase in taxes and duties by government, higher exchange rates etc.
all above causes increase the price level of goods and services and this leads to inflation.