Inflation – Inflation is a global phenomenon in present day times. It is an important and a major economic problem being faced by the developed as well as developing countries. If
a slight rise in the prices of goods and commodities is accompanied by a rise in real
income and economic development, then, it is not called inflation. But when prices rise,
costs rise and money income rises, but real income remains constant, we say that there is
inflation.
Causes of Inflation –
A) Factors causing an increase in demand - Following factors cause an increase in
demand
1) Increase in public expenditure – Government activities have been expending much with the result that government expenditure has also been increasing at a phenomenal
rate, thereby raising aggregate demand for goods and services. In fact, this is an
important cause giving rise to the emergence of excess demand in the country.
2) Increase in private expenditure – When the business conditions are good, private
businessmen are eager to spend more money on capital goods. This increases the
demand for capital goods, and in turn, brings about an increase in the demand for
consumer‟s goods. This is because there is an increase income of factors production which increases demand for goods and services. It results in the prices of goods
leading to inflation.
3) Increasing in consumer spending – The demand for goods and services increases, when consumer expenditure increases. Consumers may spend more due to
conspicuous consumption or demonstration effect. They may also spend more when
they are given credit facilities to buy goods on hire purchase and installment basis.
4) Increase in money supply – The higher the growth rate of the money supply, the higher the rate of inflation.
5) Monetary policy – When the government adopts cheap money policy, it results in
increasing purchasing power in the hand of the people. It increases demand for goods
and services which results in inflation. Reduction in the bank rate, buying of securities in the open market, repayment of the public debt; all these leads to increase in money supply and credit supply. This results into inflation.
6) Deficit financing – In order to meet rapidly expenditure, the government resorts to deficit financing. This raises aggregate demand in relation to aggregate supply of goods and services, thereby leading to inflationary rise in prices.
7) Reduction in taxation – If there is a reduction in the taxes levied by the government, people are left with more money, which can be spent. This increases their expenditure, as well as the prices of commodities.
8) Repayment of public debt – Whenever the government repays its past internal debt to the public, it leads to increase the money supply with the public. This tends to raise the aggregate demand for goods and services.
9) Increase in exports – When there is an increase in the domestic goods export, this raises the earnings of industries producing export commodities. These in turn, create more demand for goods and services within the country.
10)Black money – Due to corruption, tax evasion there is increase in black money. This increases the disposable income of the people. It increases the demand for goods and services, whereby the problem of inflation emerges in the country.
B) Factors causing a Decrease in Supply - Following are the factors which result in a reduction in the supply of goods and services.
1) Shortage of factors of production – One of the important causes affecting the
supplies of goods is the shortage of factors of production such as labour, raw material, capital, land, power supply etc. They lead to excess capacity and reduction in the industrial production.
2) Industrial disputes – The powerful trade unions use the measures like strikes, which curtail the production of goods and services. As a result, the prices rise and the
problem of inflation emerges.
3) Natural calamities – There are various types of natural calamities which may reduce
production. Natural calamities like flood, drought, earthquake, etc. disturb the productive sector and curtail the supply of goods and services. As a result, their prices
rise and inflationary situation takes place.
4) Trade policy – Government‟s defective trade policy increases export of goods and services or decreases import of goods and services. This also causes inflation.
5) Artificial scarcities – Artificial scarcities are created by hoarders and speculators who indulge in black marketing. Thus they are instrumental in reducing supplies of goods and raising their prices.
6) Lopsided production – The demand for luxurious goods increases as a result of unequal distribution of national income. Producers invest their capital in such production. So the production of essential good is reduced which creates inflation.
7) Diminishing returns to scale – The state of diminishing returns in the productive
sectors of economy raises cost per unit of produc