Causes of Inflation

Keynesian View - demand pull inflation

Keynesians believe the level of real GDP depends on AD,
If the economy is at full employment then an increase in AD leads to an increase in the price level

Keyensians believe that AD can increase due to C+I+G+X-M

· The link between output and inflation suggests that there will be a similar link between inflation and unemployment,

· The Phillips curve initially showed a link between money wages and unemployment,

· it was then argued an increase in wages would lead to inflation

Cost Push Inflation

If there is an increase in the costs of firms then firms will pass this on to consumers There will be a shift to the left in the AS

Cost push inflation can be caused by many factors

The Labour Market

If trades unions can present a common front then they can bargain for higher wages, this will lead to inflation

2. Import prices

            One third of all goods are imported in the UK. If there is a devaluation then import prices will become more expensive leading to an increase in inflation
            E.G. a German car costs DM 40,000. If the exchange rate is DM £1:3DM then it will be priced at £13,333.
            If the E.R falls to £1 : 2DM then it will be priced at £20,000

3.         Raw Material Prices,
The best example is the price of oil, if the oil price increase by 20% then this will have a significant impact on inflation

4.    Profit Push Inflation

5. Declining productivity

· Therefore if there is a demand side shock the attitude of the monetary authorities is crucial, if they accommodate this increase in AD by increasing the MS then inflation will continue to rise

Continuing Inflation

Once inflation sets in it is difficult to reduce it

· for example higher prices will cause workers to demand higher wages causing a wage price spiral.

· The attitude of the monetary authorities is important for example if there was an increase in AD and the monetary authorities accomodated this by increasing the money supply then there would be a rise in the price level

Essays and Revision Notes on Inflation

Definition - Inflation

Causes Inflation

Costs of Inflation

Monetarist Theory

Criticisms of Monetarism

Measuring Inflation

Problems Measuring Inflation

Money Supply

Hyperinflation - Causes and Costs