What are the Causes of Inflation

Fri, 07/05/2013 - 10:48 -- Umar Farooq

Following are the causes of inflation

Increase in the Quantity of Money

When the quantity of money in circulation is increased, the aggregate demand for goods and services also expands which onward exceeds the aggregate supply. Due to higher demand and lower supply too much money starts chasing too few goods and the price level goes up.

Increase in the Government Expenditures

In order to facilitate the public, the government makes expenditures in a huge amount on various developmental and non-developmental activities. Increase in the government expenditures injects more money into the economy which raises the aggregate demand hence the price level also rises.

Oil Prices

A continuous rise in the oil prices at the international level is also a cause of price hike or inflation. Every economy of the world has increased its agricultural and industrial production for which modern technology and machinery is being used. That machinery is run by oil. Thus the rising oil prices have globally added to the cost of production, resulting higher prices of the output.

Deficit Financing

I order to give practical shape to the government's projects, sometimes the government revenues fall short of its expenditures. To bridge this gap extra money is printed and injected into the economy. By this way the government fulfills its needs but the quantity of money in circulation increases continuously thus adding to the price level.

Increase in the Consumer's Disposable Income

The more is the disposable income of the consumer, the greater will be the demand for goods and services. Resultantly the aggregate supply will fall short of the aggregate demand; hence the price level will increase.

Decline in Production

One of the important causes of inflation is the decline in production, when the production of agricultural and industrial output falls short of the desired level, then the price level increases as a result of increasing demand.

Devaluation in Currency

Devaluation of currency bears serious repercussions on the purchasing power of the people because currency of falling value does not bring more goods and services to the consumer as the price level seems high.

Increase in Population

According to economists a rapidly increasing population is also a cause of inflation. According to them when the population rises at a fast rate then the demand for food, cloth, slicker, medical care and education etc. also rises but the supply of these cannot be matched with the growing demand overnight. Resultantly the price level goes up.

Black Money

The presence of black money in the economy increases the aggregate demand. By black money we mean that money which is earned through smuggling, drugs, tax evasion and corruption etc. such money is spent lavishly hence causing the aggregate demand to exceed the aggregate supply and resulting inflation.

Excessive Profit

An unnecessary and excessive profit earning attitude of the producers is also a cause of inflation. The producers intentionally charge high prices in order to earn more profit than the normal routine.