Causes of Inflation
Inflation is the increase in the general level of prices sustainable by an economy over a period of time. Economic growth, monetary policy and a decrease in the unemployment rate are the major contributing causes of inflation.
Firstly, economic growth needs to be evaluated using the nominal GDP and Real GDP of the economy of interest. Gross domestic product is one of the measures used for evaluating economic growth. Nominal GDP is then divided by the real GDP times 100. This equation gives you the amount of changes in overall prices in an economy. Inflation is seen when an economy experiences changes in economic growth. If the economy experiences higher economic growth this means there is an increase in production, which increases the demand for factors of production. When the demand increases for factors of production it causes factor payments to go up. Due to an increase in factor payments, production costs increase, therefore resulting in higher prices for consumers, and an equally higher inflation rate.
Secondly, one of the causes of inflation is monetary policy. The effects of decisions made regarding monetary policy cause changes in inflation. If a decision to increase the supply of money is made then it means there is more money in the market. If consumers have more money, their willingness and ability to purchase goods increases, therefore increasing demand. When market demand increases the prices of goods go up. The increase in prices of goods increases inflation. Monetary policy also addresses interest rates. If interest rates go up, the cost to produce go up. Producers may experience high production costs and new products may not make it into production. If new products or the current production of more products doesn’t happen, the increased interest rate inhibits economic growth.
Finally, an increase in employment can be a cause of inflation. When firms hire more employees, it increases the cost to produce. Whenever costs to produce go up, suppliers increase their price, thus indicating another inflationary change and cycle.
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