Inflation Essentially

Inflation Essentially

Inflation, essentially a fall in the value of money due to rising prices. When total monetary demand exceeds the value of the goods and services currently available for sale, the economy is subject to expansionary pressure. Business men find trade good and stocks declining; they are under strong inducements to expand output and increase their demand for factors of production. If the economy has large reserves of unemployed resources the main effect of the expansionary pressure win be to raise the level of employment until the unemployed resources are absorbed. But at high levels of employment, where there is little scope for increasing output, the excess of demand over supply causes prices to rise.

In theory the rise in prices should end the inflation by making demand equal supply at the higher prices. In practice inflation tends to become cumulative, since higher prices mean higher costs and higher costs lead to higher prices. The output of many firms is the 'input' of other firms, so that higher prices become higher costs, and because of the general buoyancy of incomes and demand higher costs are likely to be paid for by final buyers rather than out of profits. The price/cost spiral is especially evident in wage costs. Higher prices mean an increased cost of living and give a strong impetus to wage claims. Employers are anxious to avoid disruptions to production, and since they know that higher costs can be passed on in the form of higher prices, they are willing to pay higher wages . Trade unions are thus in strong bargaining positions when the level of employment is very high. But the upward pull on wage rates also comes from employers, who are anxious to increase their output and so compete to secure additional labour by offering higher pay. When there is full or 'overfull' employment, employers may find it necessary to increase labour earnings simply to retain their existing labour force, i.e. in order to stop employees leaving to take up higher-paid jobs with competitors.

In this situation total money income rises at a faster rate than real income and the difference is available to finance the excess monetary demand which causes prices to rise. An additional pressure on prices comes from the increased investment which business men undertake in order to increase output. In the long run most investment expenditures will result in a substantial increase in the output of consumer goods, but in the short run money incomes are generated by the additional activity without a corresponding increase in the output of consumer goods.

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