Page 183 - DECO201_MACRO_ECONOMICS_ENGLISH

Macro Economics

Notes 10.3.4 Sectoral Demand-Shift Inflation

In a dynamic economy, progress involves continual shifts in demand from one sector to another.
Such shifts raise the wages and prices in those sectors towards which demand shifts but do not
lead to wage and price reductions in the sectors from which demand shifts away. This is because
in a modern industrial set-up, wages and prices are flexible upwards but rigid downwards and
on balance, all prices tend to rise despite the absence of general excess demand. This notion of
inflation is attributed to Charles L Schultze.
Schultze maintains that the changes in the pattern of demand will cause a rise in prices in the
demand gaining industries, while prices remain rigid in the demand losing industries. The net
effect is that the general price level will rise, even though the aggregate demand has remained
almost unchanged. Attempts to increase production in the demand gaining sectors lead to
increase in the price of materials and wages in these sectors. The rigidity of the prices of materials
supplies and components, at the same time, will prevent a downward movement of prices in the
demand losing industries. Consequently, there will be a general rise in the prices of materials
and components.
The demand gaining sectors tend to raise wages in order to attract more workers. But the
demand losing industries may also have to resort to raising wages since they cannot permit
wage differentials to get widened lest there are large-scale desertions of workers from these
industries and wage differentials result in inefficiencies and lowered labour productivity. Wage
rise which originates in the demand gaining sectors, thus, spreads even to the demand losing
sectors and accentuates rise in the prices of semi-finished materials and components.
Schultze’s notion that a shift in the pattern of demand will cause a continuous upward movement
of prices does not seem to be well-founded. A price rise is likely to be halted if the quantity of
nominal money supply in the economy is not increased. The rising price level, though reducing
the real quantity of money (real balances), may push up the rate of interest and cause the
aggregate demand to fall, thereby bringing down the general price level.

Task Meet and interview an economist and find out how they predict the inflation rates
in the nation.

Self Assessment

Fill in the blanks:

9. The root cause of inflation lies in the imbalance between .................... and ..........................
10. ............................... is defined as an excess of planned (or anticipated) expenditure over the
available output at pre-inflation or base prices.

11. ................................... inflation occurs only when there is an inflationary gap in the economy.
12. .................................... refers to the income payments to factors after personal taxes have
been paid.

13. Cost push inflation is also known as ................................. inflation.
14. ................................. inflation occurs when wages rise faster than labour productivity.
15. The concept of inflationary gap was introduced by ...................................

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