CHAPTER ELEVEN
INFLATION
Introduction
Inflation is defined as a persistent and generalized increase in the level of prices. It is a process in which the price
level is rising at a rapid rate and the money is losing its value.
Inflation refers to an economic situation where the demand for goods and services in the economy is continuously
increasing without corresponding increase in supply which pushes the general prices up. The opposite of inflation is
called deflation. Inflation is measured by considering the Consumer Price Index (C.P.I) which involves comparison
of prices of certain goods and services for two different periods.
In constructing the C.P.I;
1. A basket of commodities is selected which includes selecting the generally consumed commodities by
average consumers.
2. Choosing the base period which should be a period when the prices were fairly stable.
3. The price of commodities both in the current period (P1) and base period (P2)
Types and causes of inflation
Inflation is classified in relation to its causes.
Demand pull inflation
This is a type of inflation caused by excessive demand for goods and services without a corresponding increase in
production resulting into rise in prices.
Causes of demand pull inflation
a. Increase in population; increased number of people in a family calls for increased demand of goods and
services thus fueling demand-pull inflation.
b. Increase in government expenditure; The government expenditure has the effect of making money available
to people thus increasing the aggregate demand for goods and services.
c. A fall in the level of savings; this increases the consumer expenditure on goods and services which brings
pressure on the available goods and services thereby pulling up prices.
d. Effects of credit creation by the commercial banks; when banks lend more money to the public, their
purchasing power increases hence increasing demand which in turn leads to increase in the prices.
e. Consumers’ expectation of future price increases; when consumers expect the prices of goods and services
to increase in the future, they will buy more in the present thus increasing the demand thus fueling demand-pull
inflation.
f. General shortages of goods and services; Any shortage in goods caused by factors such as; adverse climatic
conditions, hoarding, smuggling, withdrawal of firms from the industry and decline in level of technology calls
for scramble for the available goods thus increasing their demand and prices.
Cost push inflation
This is a type of inflation caused by increase in cost of factors of production which translates to increased prices of
goods and services.
Causes of cost push inflation.
Increase in wages and salaries; an increase in the wages and salaries may increase the cost of labor. The
increased cost of labor may be reflected in the increased prices of commodities which in turn would cause wage
push inflation.
Increase in cost of raw materials and other inputs; this increases the cost of production thus increased prices.
Increase in indirect taxes; this increases the cost of production and this causes firms to raise the prices of their
product.
Increase in profit margin; If the business decides to raise its profit, it leads to an increase in the price of the
commodities resulting to profit push inflation.
Reduction in subsidies; removal of a subsidy implies that the producer would produce at a higher cost that was
being met by the subsidy. This increase cost is finally reflected in increased prices.
Imported inflation
ECONOMICS COURSE NOTES: CHAPTER 11 – PRICE INFLATION PREPARED BY MR. ANTONY AMBIA Page 1
INFLATION
Introduction
Inflation is defined as a persistent and generalized increase in the level of prices. It is a process in which the price
level is rising at a rapid rate and the money is losing its value.
Inflation refers to an economic situation where the demand for goods and services in the economy is continuously
increasing without corresponding increase in supply which pushes the general prices up. The opposite of inflation is
called deflation. Inflation is measured by considering the Consumer Price Index (C.P.I) which involves comparison
of prices of certain goods and services for two different periods.
In constructing the C.P.I;
1. A basket of commodities is selected which includes selecting the generally consumed commodities by
average consumers.
2. Choosing the base period which should be a period when the prices were fairly stable.
3. The price of commodities both in the current period (P1) and base period (P2)
Types and causes of inflation
Inflation is classified in relation to its causes.
Demand pull inflation
This is a type of inflation caused by excessive demand for goods and services without a corresponding increase in
production resulting into rise in prices.
Causes of demand pull inflation
a. Increase in population; increased number of people in a family calls for increased demand of goods and
services thus fueling demand-pull inflation.
b. Increase in government expenditure; The government expenditure has the effect of making money available
to people thus increasing the aggregate demand for goods and services.
c. A fall in the level of savings; this increases the consumer expenditure on goods and services which brings
pressure on the available goods and services thereby pulling up prices.
d. Effects of credit creation by the commercial banks; when banks lend more money to the public, their
purchasing power increases hence increasing demand which in turn leads to increase in the prices.
e. Consumers’ expectation of future price increases; when consumers expect the prices of goods and services
to increase in the future, they will buy more in the present thus increasing the demand thus fueling demand-pull
inflation.
f. General shortages of goods and services; Any shortage in goods caused by factors such as; adverse climatic
conditions, hoarding, smuggling, withdrawal of firms from the industry and decline in level of technology calls
for scramble for the available goods thus increasing their demand and prices.
Cost push inflation
This is a type of inflation caused by increase in cost of factors of production which translates to increased prices of
goods and services.
Causes of cost push inflation.
Increase in wages and salaries; an increase in the wages and salaries may increase the cost of labor. The
increased cost of labor may be reflected in the increased prices of commodities which in turn would cause wage
push inflation.
Increase in cost of raw materials and other inputs; this increases the cost of production thus increased prices.
Increase in indirect taxes; this increases the cost of production and this causes firms to raise the prices of their
product.
Increase in profit margin; If the business decides to raise its profit, it leads to an increase in the price of the
commodities resulting to profit push inflation.
Reduction in subsidies; removal of a subsidy implies that the producer would produce at a higher cost that was
being met by the subsidy. This increase cost is finally reflected in increased prices.
Imported inflation
ECONOMICS COURSE NOTES: CHAPTER 11 – PRICE INFLATION PREPARED BY MR. ANTONY AMBIA Page 1
