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Pull Theory Of Inflation

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3. LITERATURE REVIEW
A. Introduction

Inflation is said to be not a new topic in research, it has been there for a while. This section looks at different theories of inflation and expiations on the effect of inflation and the framework.
B. Theories of Inflation
There have been various economists that have explained the inflationary situation in an economy. This section will focus on the literature review 4 of theories of inflation. This includes Keynesian approach; cost push theory and demand pull theory.

1. The Keynesian Approach

According to Keynesian economists deficit budget has no inflationary pressures, but it affects the price level by impact on aggregate money and consumer expectations. Keynesian view was that if there is a short …show more content…

Cost Push Theory
Cost push theory is where inflation is due to direct result of increase in the cost of production that is increase in prices of raw materials, increase in labour cost (wages & salaries). Cost push inflation can be also defined as prices have been “pushed up’ due to increase in price for factors of production. So as the cost push theory says inflation is caused by increase in cost of production factors, this leads to decrease in the demand for raw materials, which leads to decrease in production and demand stays consistent, than this leads to increase in price (inflation).
The figure 1.0 shows what happens in the cost push theory. If the firm is operating at point Q1, P1 any increase in price for factors of production will lead to increase in price that is moving from point P1 to P2 quantity supplied decreases due to increase in cost for factors of production moving from Q1 to Q2. As firm’s main aim is to make and increase profits, they will need to increase price, and this causes …show more content…

As the interested customers will be willing to pay higher prices to purchase these goods. This theory is also part of Keynesian argument.
The figure 2.0 shows what happens in demand pull inflation. So as the demand increases the prices also increases moving from AD1 to AD3. Figure 2.0

C. Effects of Inflation

Firstly, due to inflation the value of money falls. This means that the $1 that use to buy the goods before, if used in inflationary period that same $1 will buy less goods than before. So in other words purchasing power of the money has fallen.

Secondly, income and wealth are not distributed effectively. Inflation has pervasive effect on the people who largely depend on fixed income; like salary earners and pensioners. Due to this the borrowers gain while lenders lose.
Thirdly, crisis in balance of payment can arise. Due to inflation people prefer to sell goods rather than buying goods.

Finally, economy will have low economic growth. Most of the firms will not want to borrow money and expend their business or buy fixed assets. This is because during inflation interest rate is high, so firms do not expend their business, so low growth and

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