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Monetary policy can reduce the rate of inflation by raising the interest rate and regulating the credit flow in the market. Announcing our NEW encyclopedia for Kids! A usual characteristic of such markets is that the money wage rate is inflexible downward, the result of which is an aggregate supply curve of the kind shown by S0S. They have provided two types of theories to explain the causes of inflation, which are shown in Figure-4: Let us study the different types of structural theories of inflation (as shown in Figure-4) in detail in the next sections. Increase in wage rate has pushed S0S curve to S1S. It implies a steady increase in the price level over time. Share Your PPT File, Cost-Push Inflation and Demand-Pull or Mixed Inflation, Public Sector Enterprises or Undertakings in India.

General equilibrium is established at Y0 and i0 with price level p0. In such a situation, people in middle and low income groups reduced the consumption of onions. Inflation is generally thought of as an inordinate rise in the general level of prices. Such groups keep prices at the level at which they can earn maximum profit without any concern for the purchasing power of consumers. This is the celebrated quantity theory, going back at least as far as David Hume in the 18th century. The increase in prices levels stimulates production, but increases demand for factors of production.

For any level of national income, therefore, there is a gap of a predictable size between income and consumption expenditure, and to establish and maintain that level of national income it is only necessary to fix expenditure on all nonconsumption goods and services at such a level as to fill the gap. Most can be divided into two broad areas: quality theories of inflation and quantity theories of inflation.

One proposal for achieving the “optimal” result—indeed the most widely discussed proposition in the pure theory of monetary policy—is that the inflation rate should be sufficiently negative that the nominal rate of interest is zero (on bonds of zero default risk and the shortest maturity). In a refined version, the quantity theory was revived by Milton Friedman and other University of Chicago economists in the 1950s and ’60s. The rise in wages and costs leading to rise in prices (wage-price spiral) will come to an end. Share Your PDF File From a theoretical view, at least four basic schemata commonly used in considerations of inflation can be distinguished. According to an important variant of the cost-push theory, sectoral shifts in demand are the main causes of the inflationary process. Different economists have presented different theories on inflation. Share Your Word File With increase in the income of individuals, their purchasing power also increases, which further results in inflation. Cost-Push Inflation: When the demand for money becomes inelastic, all funds are used for transaction purposes, and further increases in the aggregate demand can then be financed only by a reduction in expenditures elsewhere in the economy or by an increase in the transactions velocity of money. In addition, he also advocated that during inflation prices in every industry is higher, but few industries show a very high price hike than rest of the industries.

Welcome to EconomicsDiscussion.net! Omissions? Privacy Policy3. They emphasised the fact that cost-push inflation is caused by wage increases due to strong trade union activities on the part of labour. Share Your PDF File With the initial SoS and D0 curves in the Figure 32.7, we can turn to the process by which increases in the money wage rate push up the price level.
Thus, we find that according to this theory of demand-pull inflation, prices rise in response to an excess of aggregate demand over existing supply of goods and services caused by an increase in the quantity of money—resulting in a fall of interest rates—increasing investment expenditures and prices. Demand-pull inflation refers to the inflation that occurs due to excess of aggregate demand, which further results in the increases in price level. Consider the diagram 32.6, which analyses the working of excess demand inflation irrespective of the fact whether excess demand is caused by increased money supply or by expenditures on C and I. The increase in wages is compensated with the hike in prices of products. The major difference between the two theories of the inflationary process centres on the responsiveness of both the money wages and prices to change in demand. Encyclopaedia Britannica's editors oversee subject areas in which they have extensive knowledge, whether from years of experience gained by working on that content or via study for an advanced degree.... Get exclusive access to content from our 1768 First Edition with your subscription. But demand-pull inflation may also be caused without an increase in money supply—when MEC or MPC goes up causing an increase in expenditures and hence prices. Thus, cost-push inflation once set in motion in one industry or sector, spreads like wildfire in the whole economy. National output now exceeds the equilibrium level of output. Their view is that the general price is determined by the total demand for and total supply of goods just as the price of any good is determined by the forces of demand and supply for it. Apart from the two extreme ends mentioned in the above, there is a middle group of economists called structural economists. However, both monetarists and Keynesians reject the idea of administrative type cost-push inflation—in fact monetarists reject all versions of cost-push inflation. The theory assumes that prices for goods and services as well as for economic resources are responsive to supply and demand forces, and will, thus, moves readily upward under the pressure of a high level of aggregate demand. According to them, the general price level rises due to the proportionate increase in the supply of money, output remaining the same. In the Fig. The adjacent Figures show cases of mixed inflation. The shortage of products in the market would result in the further increase of prices. In addition in full employment condition, the economy reaches to its maximum production capacity. That is why many cost-push inflation experts advocate mitigation rather than elimination of inflation.

The relative stability of the velocity of circulation is attributed by them to the facility with which the supply of money accommodates itself to demand; they argue that insofar as supply may be restricted in the face of rising demand, velocity will increase, or (what really amounts to the same thing) new sources of credit, such as trade credit, will be exploited. At this point, the supply of goods and services cannot be increased further while the demand of products and services increases rapidly. https://www.britannica.com/topic/inflation-economics, The Library of Economics and Liberty - Inflation, inflation - Student Encyclopedia (Ages 11 and up). Against this, it has been argued that in highly developed economies the supply of money varies largely with the demand for it and that the authorities have little power to vary the supply through purely monetary controls. This results in fall in supply at increased level of prices as to compensate the increase in wages with the prices of products. Increase in demand results in the increase of prices of products as the customers spend more on products. This has happened in steel, cement, coal, oil industries in the world and in India where there has been 30 to 50 per cent increase in prices despite high unemployment of both men and machines. The uncertainty and weakness of the relation between interest rates and private investment are another source of difficulty. A price increase instigated autonomously by monopolistic busi­ness groups or as a result of wage pressure raises the price level to p1 and thus shifts the LMp0 schedule to LMp1. However, he believed that wage push or market-power theories alone are not able to provide a clear explanation of inflation. Many economists have come to believe that the actual process of inflation is neither due to demand-pull alone, nor due to cost-push alone, but due to a combination of both the elements of demand-pull and cost-push—called mixed inflation.

So long as these remain constant, the price level will be directly proportional to the supply of money and inversely proportional to the physical volume of production. Articles from Britannica Encyclopedias for elementary and high school students. It is due to rising cost on account of wages that workers and employers try to include escalator clauses in labour contracts, agreeing to raise wage rates as soon as there is a rise in the cost of living index.
According to him, inflation cannot occur alone by demand and cost factors, but it is the cumulative effect of demand-pull and cost-push activities. The theory of demand-pull inflation relates to what may be called the traditional theory of inflation.

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