MONEY AND INFLATION — Economics STD 12 Commerce — Question
Gujarat BoardEnglish MediumSTD 12 CommerceEconomicsMONEY AND INFLATION5 Marks
Question
Define inflation and explain the causes of inflation.
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Answer
Inflation:
An increase in price level of goods or services over a period of time is called inflation.
The two major aspects that affect the price of goods and services are: Demand and Supply.
Based on these two aspects we can say that inflation is affected by two major factors namely,
$(A)$ Increase in demand and
$(B)$ Increase in production cost.
$(A)$ Increase in demand:
If the demand of a product rises, its price rises. Similarly, when the demand increases and the supply is lesser than the demand even then price rises.
In economics if inflation takes place due to increase in demand compared to supply then such inflation is called ‘Demand-pull inflation’. The major reasons for increase in demand are following are discussed below.
$1.$ Increase in supply of money:
Monetarists consider inflation as a purely monetary phenomenon.
According to them, if the quantity of money increases in an economy then income of people rises.
When income rises affordability of people increases and they demand more goods and services. This increases the demand of goods and services. Against this increasing demand, the supply does not increase much and so it leads to inflation.
According to Machlup, “Too much money chasing too few goods causes inflation”. In other words, increased demand demanding more goods i.e. more money demanding more goods whose supply is pretty less.
$2.$ Increase in public expenses $($Government expenses$):$
The government of developing countries like India is involved in economic development of the country.
In order to achieve economic development it invests huge money through various projects related to employment, fulfilling basic requirements, raising infrastructure and financial infrastructure. The money put in these projects increases the supply of money in economy.
Owing to these investments people start gaining more income and their purchasing power increases. They then demand more goods and services. This increases the demand of goods and services which leads to inflation.
The inflation rises even faster when the government does huge public expense and supplies more money for economic development as compared to production of goods and services done in the market.
$3.$ Over-population:
In India every year the population increases by $2\%.$ The increasing population demands more goods and services. Price rise takes place when the supply is not able to match up with this rising population.
Alternatively, if there is no rise in population i.e. it is steady but the purchasing power of people increases even then it leads to price rise.
$(B)$ Increase in cost of production:
Supply is the second major factor that affects the price of goods. People who support the theory of ‘supply-side economics’ believe that when the production cost increases the price of the good also increases.
If there is an increase in cost of raw material, machines, electricity, water rates, worker’s wages or transportation it will lead to increase in price of goods or services.
Inflation caused due to increase in production cost is called ‘Cost-push inflation’ or ‘Supply shock inflation’.
$(C)$ Other reasons:
Several other factors can affect the inflation. Some factors may look minor factors and may also affect for a short term but still such factors can shoot the price levels.
For example, in case of industries that are dependent on foreign import, increase in import taxes or accidental shortage of some items can also lead to price rise.
Some important minor factors that may cause inflation are discussed below:
$1.$ Taxation policy:
The taxation policy of the government causes inflation.
High increase in tax rates increases the production cost of the products which leads to rise in inflation.
$2.$ Increase in import price:
India imports $70\%$ of its total required petroleum products.
When the price of crude oil rises in international market it will lead to rise in price of petrol and diesel. This then increase price of several other products too.
$3.$ Scarcity:
Scarcity of raw material, electricity or any resource needed for production leads to increase in price levels of the goods or services.
If scarcity prevails for a longer period during production or is extensive in nature it can cause inflation.
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