The Demand-Pull Inflation - Essay Example

Inflation is the consistent and sustained general price increase of commodities over a period of time leading to fewer goods being purchased with every unit of the current currency. Inflation indicates a loss in purchasing power based on each unit of money within an economy. This is measured through the consumer price index over a specified duration of time (Hart, 2009). There are two major causes of inflation in any economy which are demand-pull inflation and cost-push inflation both of which will be discussed below in detail and their effects explained as well.

Causes The demand-pull inflation occurs when the demand for goods or services exceeds the ability to produce them or exceeds the supply. Suppliers start increasing the prices of the reduced goods and services when they start realizing their diminishing supply. If this continues, the central bank starts increasing the supply of money as a reaction to the aggregate demand. With the increase in money supply in circulation, businesses cannot increase production and hence supply remains constant for a short while but this leads in the long run to an increase in equilibrium and prices rise resulting therefore to inflation (Tucker, 2012).

According to the illustration, Demand moves from D0 to D1, and the supply remains constant for a while but then the equilibrium shifts from A to B leading to a price increase and hence inflation. Source: http://econrsrch/wklyltr/2000/el2000-21.html. The cost-push inflation is the other cause of inflation where there is an increase in the cost of production which ultimately leads to an increase in the prices of raw materials and wages. This increased cost by the firms is passed on to consumers. The cost-push inflation is caused by a monopoly company, inflation in wages, natural disasters when the natural resources deplete when the foreign exchange rates fall leading to a reduction in the imports, or by the government when it increases its taxation (Tucker, 2012).

All the above-mentioned situations lead to a reduction in supplies. In the illustration, when the production cost increases caused by any of the above-mentioned factors, the supply reduces from S0 to S1. The high demand and the reduced supply lead to a shift in the equilibrium and ultimately an increase in the price level from Z to Y causing inflation to take place. Source: http://econrsrch/wklyltr/2000/el2000-21.html. Effects There are positive and negative effects of inflation. The positive effects of inflation include the fact that with inflation, the central banks adjust the interest rates as a way to mitigate the economic recession.

This then leads to a ripple effect as banks also adjust their interest rates causing more people to take up loans and mortgages in a bid to deal with the consistently increasing prices and diminished supply. The banks therefore benefit from all this even though mainly it is for a short while depending on how long the inflation last (if it lasts for long, the loss as people will be unable to repay the loans and mortgages). The other positive effect is that with inflation looming, investment is directed to non-monetary projects which otherwise suffer when there is no inflation as people do not get time to invest their time and energy in them but with inflation they become able to (Dwivedi, 2010).

The negative effects however surpass the positive ones. These negative effects range from loss of employment leading to massive unemployment as companies that cannot afford to pay wages dismisses their workforce leaving only a few who are overworked with no pay increase while others close their doors as they declare bankruptcy. There is also the fact that people start reducing their spending and usage rates as commodities become rare or the money to buy them dwindles causing a change in the number of meals per day, others go hungry and homeless as they fail to repay mortgages or their other debts.