Assess The View That Inflation Is Always Caused By An Increase In Aggregate Demand
Assess the view that inflation is always caused by an increase in aggregate demand
Inflation is a sustained general rise in the price of goods, measured by the annual percentage increase in average prices.
Inflation can be caused by an increase in aggregate demand, Aggregate demand is the demand for the gross domestic product (GDP) of a country, and is represented by the formula: Aggregate Demand (AD) = C + I + G + (X-M). An increase in aggregate demand can be caused by many factors such as a decrease in income tax which in turn increase the amount of disposable income people have, which therefore increase consumer spending, higher wages would have the same effect of increasing consumer spending. Also if there were low interest rates then consumers would be less likely to save and more likely to spend which again would increase consumer spending. An increase in the budget deficit would increase government spending which would again increase AD, as well as this if there is a ‘depreciation of the pound sterling’ then there would be an increase in export as there would be cheaper, however there would be a decrease in imports as they would be more expensive therefore increase AD.
Demand pull inflation is caused when there has been excessive growth in AD. An example of demand pull inflation was in the late 1980s in the UK as shown in the diagram below.
From AD to AD1 the economy is still operating at low levels of capacity and as shown in the diagram there is a large output gap. However as AD increases from AD1 to AD2 the output gap decreases, so there are shortages of raw materials and many firms will widen their profit margins, feeling confident about consumer demand, so they will increase there prices.
The second cause of inflation is an increase in the costs of production, costs of production may have risen as a result of high oil prices as stated in extract C ‘oil prices remained at very high levels’ this would increase machinery
Inflation is a sustained general rise in the price of goods, measured by the annual percentage increase in average prices.
Inflation can be caused by an increase in aggregate demand, Aggregate demand is the demand for the gross domestic product (GDP) of a country, and is represented by the formula: Aggregate Demand (AD) = C + I + G + (X-M). An increase in aggregate demand can be caused by many factors such as a decrease in income tax which in turn increase the amount of disposable income people have, which therefore increase consumer spending, higher wages would have the same effect of increasing consumer spending. Also if there were low interest rates then consumers would be less likely to save and more likely to spend which again would increase consumer spending. An increase in the budget deficit would increase government spending which would again increase AD, as well as this if there is a ‘depreciation of the pound sterling’ then there would be an increase in export as there would be cheaper, however there would be a decrease in imports as they would be more expensive therefore increase AD.
Demand pull inflation is caused when there has been excessive growth in AD. An example of demand pull inflation was in the late 1980s in the UK as shown in the diagram below.
From AD to AD1 the economy is still operating at low levels of capacity and as shown in the diagram there is a large output gap. However as AD increases from AD1 to AD2 the output gap decreases, so there are shortages of raw materials and many firms will widen their profit margins, feeling confident about consumer demand, so they will increase there prices.
The second cause of inflation is an increase in the costs of production, costs of production may have risen as a result of high oil prices as stated in extract C ‘oil prices remained at very high levels’ this would increase machinery