The rising cost of living is concerning, to say the very least, caused by many factors. Inflation is one of the more direct of those factors, which is why we feel it pertinent to explore exactly what causes inflation and why it is causing the current #BritsOnCostOfLiving crisis to be so hard on many families.
The main causes of inflation are excess aggregate demand (AD) (too-rapid economic growth) or cost factors (supply factors). One of the main causes of inflation is an increase in the money supply. Cost-push inflation can occur even if the supply of money in circulation exceeds the demand for it. On the other hand, demand-driven inflation drives up prices when consumers show a sustained interest in a service or product.
Demand-Pull
Demand pull occurs when an increase in demand for goods and services causes producers to raise prices to maximise profits. Cost-push inflation, or the cost-push effect, is when the cost of producing goods and services rises, which also causes the prices of those goods and services to rise. Cost inflation occurs when prices rise due to rising production costs such as raw materials and wages. As a rule, inflation occurs as a result of an increase in the cost of production or an increase in demand for goods and services.
The change in inflation is caused by a number of factors, such as rising production costs or surges in demand. Inflation is caused by a gradual increase in the prices of goods and services throughout the economy. Inflation is nothing but a general rise in prices throughout the economy. Inflation is a general increase in prices and a decrease in the purchasing power of money.
Excess Demand
Inflation is usually the result of excess demand chasing a limited supply of goods or services, causing prices to rise. Inflation usually means higher prices for goods and services due to high demand, shortages or supply chain and logistics issues. When commodity prices rise (due to cost-driven inflation or demand-driven inflation), this is an indication that general inflation in the economy may be occurring. While short-term imbalances between supply and demand are usually not a problem, persistent demand can reverberate in the economy and increase the cost of other goods; the result is demand-driven inflation.
If the money supply increases faster than the rate of production, it can lead to inflation, especially demand-driven inflation, because too many dollars will chase too few goods. The money supply is important because if the money supply grows faster than the economy’s ability to produce goods and services, inflation occurs. If the demand for goods increases, for example due to low unemployment, the cost of goods is likely to increase as well, at least before production can catch up. Thus, if workers organise for fair or decent wages and the cost of labour rises, goods and services may start to cost more than the artificially low price, leading to inflation.
Built-in inflation or the built-in effect is when the cost of living rises, leading to what is nothing short of the cost of living crisis we’re experiencing, which also causes wages to rise.
Supply Chain Bottlenecks
Supply chain bottlenecks can lead to inflationary pressures within an economy. When these bottlenecks occur, various factors can contribute to rising prices across sectors. Firstly, disruptions in the supply chain can result in delayed production and delivery of goods and materials. As a result, the supply of certain products dwindles, while demand often remains constant or increases. This demand-supply imbalance can lead to a situation known as demand-pull inflation, where consumers are willing to pay more for the limited available goods.
Furthermore, supply chain disruptions can increase production costs for businesses. Delays, transportation challenges, and higher expenses associated with securing materials can force companies to spend more to maintain or increase their production. To offset these additional costs and protect their profit margins, businesses may raise prices, further contributing to inflation.
In some cases, supply chain bottlenecks can create a ripple effect, impacting multiple industries. For instance, a delay in semiconductor chip production can affect the automotive sector, which may, in turn, affect the prices of vehicles and related products. Overall, these phenomena can be a significant driver of inflation, affecting the purchasing power of consumers and the overall economic landscape.
Inflation expectations
High inflationary expectations can create a self-fulfilling cycle in the economy. When people anticipate rising prices, they tend to seek higher wages to maintain their purchasing power. In response, firms may raise their prices to cover increased labor costs, raw materials, and other expenses. This wage-price spiral is a key driver of inflation.
Moreover, inflation often results from an excess of aggregate demand over aggregate supply. When demand for goods and services surpasses what the economy can produce efficiently, firms may struggle to meet consumer needs, leading to price increases. This demand-pull inflation typically occurs during periods of robust economic growth when consumer spending and business investment are high.
Central banks play a crucial role in managing inflationary expectations by implementing monetary policies such as interest rate adjustments and controlling the money supply. These actions aim to balance aggregate demand and supply, keeping inflation in check and fostering economic stability.
