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CAUSES OF INFLATION

RAVITA SURAJBALI, ANNA JIANG AND DENUGA THEIVENDRARAJAH

QUANTITY THEORY OF MONEY


positive relationship between changes in money supply and prices of goods amount of money = prices of goods and services money supply economic output amount of money = purchasing power of money; higher prices for same quantity of goods and services

EQUATION OF EXCHANGE: M x V = P x Q | PQ = GDP M: money supply | V: velocity of money | P: average price level | Q: quantity of goods and services produced. Assumes V and Q are constant in the short term. Change in M changes price levels and/or supply of goods and services; primarily M that influences changes in spending. AMOUNT OF MONEY X VELOCITY OF CIRCULATION = TOTAL SPENDING Example: An economy has $10. Those $10 were spent 10x in a year. Total spending would be $100.

DEMAND-PULL INFLATION
In a situation where there is full employment but total injections exceed total leakages An overabundance of money in relation to the goods and services it can buy No further increase in real income or in real output because the factors of production are used to the maximum output, producing as much as it can Possible to increase the production of one good at the cost of diminishing the output of another good High demand for limited resources result in a higher prices for goods and services and will continue to rise as long as the amount of spending continues to increase Real output could only increase up to the rim of the bucket, but money output will continue to rise Total injection or total demand pull up prices, this is called demand pull inflation Caused by excessive total spending or demand compared to the total amount of goods and services available in the economy Often described as too much money chasing too few goods

COST-PUSH INFLATION
Cost-push inflation is also referred to as sellers inflation Occurs when wages or the rising costs of raw materials are passed along in the form of higher prices Emphasize supply or cost forces as the dominant cause Costs are pushed up by rising prices Increased costs are passed on to consumers, causing a rise in the general price level With higher production costs and productivity maximized, companies cannot maintain profit margins by producing the same amounts of goods and services Stagflation: high level of unemployment (stagnation) and a high level of inflation

COST-PUSH INFLATION BREAKDOWN: Unions demand higher wages for their members Higher wages = an increase in costs for firms Firms raise prices of goods/services to protect profits Consequently, price for the good or service is raised Increase in disposable income which impacts unions to demand greater wages for members Wage price spiral: increased wages are followed by higher prices, which are followed by higher wages, and so on; cause and effect relationship which leads to a continuous cycle ~1~