Inflation is a situation where the prices of goods and services rise. It is a persistent rise in the prices of goods and services in food, transportation and general commodities. It is a change in the average level of price for goods and services. During inflation the prices of goods and services will tend to increase drastically. The living expenses will increase drastically higher than expected during the period of inflation.
Factors which cause inflation are demand and supply. The rise in price of general goods and commodities is due to the demand and supply of the products and services. Economists have defined factors affecting demand and supply as below. Inflation is caused by the changes in these two factors: the demand and supply.
Factors affecting the demand.
- Increase in Money supply
- Increase in spending income
- Increase in public expenditure
- Deficit financing
- Black money
1. Increase in Money supply
The increase in supply of money results in an increase in demand. The more the growth of money supply the higher is the rate of inflation. Many modern economists do not believe that real inflation starts after full employment level. This is practically true as many advanced nations have faced high levels of unemployment and inflation.
2. Increase in spending income
When the spending capacity of the population increases then the demand for goods and services increases. As everyone has more money they tend to buy more and spend more. Disposable income may increase with the increase in national income.
3. Increase in Public expenditure
When the government activities increase, the spending from the government also increases and the demand for the goods and services will increase dramatically. Government spending will be on development and the developing countries will focus more on social welfare and public services. When there is a continuous increase in public expenditure the rise in prices will create an inflation situation.
4. Deficit financing
To meet the increase in expenditures, the government will follow the deficit financing method where the government will borrow money from the public and in some situations will print extra currency. This will raise the total demand for goods and services and prices will increase consistently.
5. Black Money
Social evils exist in all the countries, one of them is the black money. The presence of black money is because of corruption, tax evasion and other reasons. The unearned income and the unaccounted income creates fluctuations in the demand and supply of the products which will result in inflation.
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Factors affecting supply
- Industrial disputes
- Shortage of factors of production
- Natural calamities
- Increase in exports
- International factors
1. Industrial disputes
In nations where the trade unions are more powerful, they will tend to affect the supply of goods. Trade unions when they go on strike the supply of goods and services will effect and this will impact on productivity and income. In such situations, the productivity of labor will reduce and the supply will be shortage resulting in increase in prices.
2. Shortage of factors of production
Factors of production such as land, labor, capital and organisation when they get affected the inflation will tend to increase. It will result in more work capacity and reduce industrial production. When there is low production and high demand the prices of goods and services will increase drastically.
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3. Natural Calamities
The natural calamities such as earthquake, floods, storms, drought and others. When they occur, they will adversely affect supply of products and services. This will create a shortage of products and services. When there is a shortage of products and services, high demand will result in an inflationary situation.
4. Increase in exports
When the country produces more goods and services for export than the demand and supply of domestic consumption, it will create a shortage of goods and services within the country. Since there is a shortage of goods and services which are directed towards exports, this will cause inflation in the country.
5. International factors
Inflation is a global phenomenon and when the prices of goods and services rise, it will affect almost all the countries with which it has trade relationships. The increase in price of raw materials will affect the international markets and it will result in an increase in price of goods and services. When there is a continuous increase in prices of goods and services, inflation will occur.