Inflation:

The rate at which the general level of prices for goods and services is rising, and, subsequently, purchasing power is falling. Central banks attempt to stop severe inflation, along with severe deflation, in an attempt to keep the excessive growth of prices to a minimum. Inflation pared down to the essentials means a rise in an index consisting of many goods that have weights attached to them. The index always has a base year. If a particular item has a higher weight and its price rises, it will have a greater effect on the inflation rate. At the end of the day it depends on how much weight a particular item is assigned. Most countries use a consumer price index (CPI) while India has a wholesale price index (WPI). As their names suggest, the CPI pertains to a set of items that a consumer consumes while the WPI is a basket particular to the wholesale market. Therefore, if the inflation for a particular week is, say, 10 per cent, it means the index is 10 per cent higher than it was the same week the previous year. Then there is core-inflation, which means the inflation rate without taking into account food and fuel. Some say both need to be taken out because of their volatility, while some argue that both items cannot be taken out because a consumer does pay for the rise in their prices. The people arguing for the latter do have a point. Milton Friedman once said: "Inflation is always and everywhere a monetary phenomenon." What exactly does that mean? It essentially means that inflation is always caused because of too much money in the system. In other words, inflation in a country is always caused because the supply of money is much greater than the demand for it. However, Prof Friedman later changed that to: "Substantial inflation is always and everywhere a monetary phenomenon," meaning that hyperinflation (a monthly inflation rate of 50 per cent or more) is caused because of too much money in the system and is usually the result of the central bank printing too much money to finance government operations. Following are some of the reasons that cause Inflation. 1) Excess printing of money. 2) Rise in production and labor costs. 3) High lending levels & Currency devaluation. 4) High level of taxes

Demand-Pull Inflation:
The inflation resulting from an increase in aggregate demand is called demand-pull inflation. Such inflation may arise from any individual factor that increases aggregate demand, but the main ones that generate ongoing increases in aggregate demand are 1. Increases in the money supply 2. Increases in government purchases 3. Increases in the price level in the rest of the world

Inflation caused by an increase in aggregate demand, is inflation caused by factor 4 (An increase in the demand for goods). The three most likely causes of an increase in aggregate demand will also tend to increase inflation:
1. Increases in the money supply: This is simply factor 1 inflation. 2. Increases in government purchases: The increased demand for goods by the

government causes factor for inflation. 3. Increases in the price level in the rest of the world: Suppose you are living in the United States. If the price of gum rises in Canada, we should expect to see less Americans buy gum from Canadians and more Canadians purchase the cheaper gum from American sources. From the American perspective the demand for gum has risen causing a price rise in gum; a factor 4 inflation.

Cost-Push Inflation:
A phenomenon in which the general price levels rise (inflation) due to increases in the cost of wages and raw materials. Cost-push inflation develops because the higher costs of production factors decrease in aggregate supply (the amount of total production) in the economy. Because there are fewer goods being produced (supply weakens) and demand for these goods remains consistent, the prices of finished goods increase (inflation). The two main sources of decrease in aggregate supply are An increase in wage rates An increase in the prices of raw materials These sources of a decrease in aggregate supply operate by increasing costs, and the resulting inflation is called cost-push inflation.

Other things remaining the same, the higher the cost of production, the smaller is the amount produced. At a given price level, rising wage rates or rising prices of raw materials such as oil lead firms to decrease the quantity of labor employed and to cut production." Aggregate supply is the "the total value of the goods and services produced in a country" or simply factor 2, "The supply of goods". The supply of goods can be influenced by factors other than an increase in the price of inputs (say a natural disaster), so not all factor 2 inflation is costpush inflation. Of course, the next question would be "What caused the price of inputs to rise? Any combinations of the four factors could cause that, but the two most likely are factor 2 (Raw materials such as oil have become more scarce), or factor 4 (The demand for raw materials and labor have risen). The terms cost-push inflation and demand-pull inflation are associated with Keynesian Economics. Without going into a primer on Keynesian Economics can still understand the difference between two terms.

In articles such as "Why Does Money Have Value?", "The Demand for Money", and "Prices and Recessions" we've seen that inflation is caused by a combination of four factors. Those factors are: 1. The supply of money goes up. 2. The supply of goods goes down. 3. Demand for money goes down. 4. Demand for goods goes up. Demand-pull inflation is often seen as the flip side of cost-pull inflation, which creates higher prices because of an increase in the cost of raw materials or labor. Since the production costs of the goods are not generally a factor in demand-pull inflation, the economy usually adjusts quickly after the spike in consumer demand has ended. The conditions which cause costpull inflation, on the other hand, may last for months or even years if the labor or material issues are not addressed successfully. Demand-pull inflation is a problem many of the world's economies wouldn't mind experiencing, since it only occurs when the gross national product (GNP) is rising and the employment rate is falling.

Inflation in Summary:
Cost-push inflation and demand-pull inflation can be explained using four inflation factors. Costpush inflation is inflation caused by rising prices of inputs that causes factor 2 (The supply of goods goes down) inflation. Demand-pull inflation is factor 4 inflation (The demand for goods goes up) which can have many causes.

By: Abhishek Mishra ISBE-A//SS//10-12 IIPM, Ahmedabad