Causes & Consequences of Inflation | Economics for GCSE/IGCSE - Year 11 PDF Download

The Causes of Inflation

• Rises in the overall price level in an economy can result from either demand-pull inflation or cost-push inflation.

Demand Pull Inflation

• Demand-pull inflation arises from an excess of demand within the economy.
• Total (aggregate) demand comprises the total expenditure in the economy.
  • rGDP = Consumption (C) + Investment (I) + Government spending (G) + Net Exports (X-M)
• If any of the four components of rGDP experience an increase, it will result in a rise in total demand within the economy, thereby leading to an increase in the general price level.
• This situation indicates the occurrence of demand-pull inflation.

An Example of Demand Pull Inflation:
A reduction in the base rate by the Central Bank typically stimulates increased borrowing by both firms and consumers.

• This, in turn, fosters heightened levels of consumption and investment, consequently boosting rGDP.
• Such a scenario is likely to precipitate a form of demand-pull inflation.

Cost Push Inflation

• Cost-push inflation results from rises in production costs within an economy.
• Any increase in production costs, such as labor or raw materials, or a decrease in productivity, will diminish total supply.
• A reduction in supply drives prices upward, resulting in an escalation of the general price level.
• This situation indicates the occurrence of cost-push inflation.

An Example of Cost Push Inflation:

• Trade Unions negotiate elevated wages for workers.
• These wage hikes constitute heightened production costs for firms.
• Consequently, firms curtail production due to increased inputs, resulting in diminished supply and elevated general price levels.
• This scenario indicates the emergence of cost-push inflation.

The Consequences of Inflation

The Impact Of Inflation On Different Stakeholders