(a) Define inflation. (b) Identify any three causes of: (i) demand-pull inflation; (ii) cost-push inflation .

Answer Details

(a) Inflation is a persistent and general rise in the average level of prices of goods and services in an economy over a period of time, which reduces the purchasing power of money.

(b)(i) Three causes of demand-pull inflation. This occurs when aggregate demand grows faster than the economy's ability to supply goods, so "too much money chases too few goods." Causes include:

• Increased government spending not matched by higher output, which injects more money into the economy.
• Excessive money supply / easy credit, for example low interest rates that raise borrowing and spending.
• Rise in consumer incomes or export demand, which raises total spending on available goods.

(b)(ii) Three causes of cost-push inflation. This occurs when rising costs of production force producers to raise prices even without extra demand. Causes include:

• Higher wages won by workers that are not matched by higher productivity, raising labour costs.
• Rising cost of raw materials or imported inputs, for example a rise in fuel prices or a fall in the value of the currency that makes imports dearer.
• Higher indirect taxes (such as increased VAT or import duties) that add to production and selling costs.