Page 200 - DECO402_Macro Economics

Unit-22: Inflation

increasing private business expenses or war or increasing Notes
government expenses for economic development. Heavy
expenses, without favourable increase in supply of actual
production, will create huge monetary income and in this
manner create demand. It is clearly inflationary in nature.
During the Second World War, because of the increase in
government expense on an unprecedented scale, almost all Cost Level
the nations of the world had to face demand pull inflation.
Apart from this, for increased income, foreign expense on
domestic goods and services is another responsible factor.
This factor is important for that country, which maintains an
export surplus. But if the created income is spent on imports Income
or is accumulated, it will not have an inflationary effect on Figure 22.1
the economy.
e. Cost Push Inflation: Cost push inflation is created
when because of raw material, intermediate
goods and increase in labour costs of productions
of the industries increase. Because of it, there
will be an increase in consumer goods. When
production cost increases, then collective supply
curve, showing this that at prevalent prices,
less amount will be supplied, has shifted to the Cost Level
left. Downward shifting of the supply curve
from S to S , S and S has been shown in figure
3
4
1
2
22.2. Assuming the collective demand curve to
be stable, decrease in supply increase the price
level upwards from OP to OP , OP and OP Income
3
4
1
2
respectively. Many factors are responsible for
upward movement in costs. Figure 22.2
(i) Higher Wage rates: Along with development of powerful trade unions, labours successfully
attain high wages for themselves. These wages may be more then the increase in their
productivity. When firms realize that their labour cost is increasing then, to save the high
cost they increase prices. Increase in price of goods induces high cost of living and reduction
in actual wages. For neutralising this reduction, labours demand for further increase in
their wages. Under any circumstance, final load of increase in prices has to be borne by
the consumer. The cycle of increase in wage rates consequently, increase in costs creates
an inflationary pressure in the economy (Wage-Price-Spiral), which is known as Cost Push
Inflation. Such inflation is found in imperfectly competitive market. Where labours are
unorganised or is suppressed by powerful industrial authorities, there it (this inflation) is
not possible.
(ii) Higher Profit Margins: Cost may also be increased by setting higher profit margins by
monopolist producers, stockists, and traders. They are in a condition to increase the prices
more than sufficient for indemnifying any loss. Other people in the market are at the mercy
of the monopolist, they have no choice but to accept them (the costs). Since demand is more
than the supply, hence producers have profit. But in freely competitive market, possibility
of cost push inflation is banned. It is true for the markets of agricultural products. But, when
prices of agricultural products are fixed by the government, then organised farmers lobby
may have some control on that price, at which it sells the agricultural produce. Farmers’
lobby in India has been successful to quiet an extent in compelling government in keeping

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