Theory of inflation And Demand Pull Inflation

Nasir Mehmood Chaudhary January 01, 2020

Modern Theory of inflation:
Definition:
Inflation is a situation when price increase is Irreversible in the market .it is called inflation.
Definition in Money Market:
Inflation is a condition of rise in the stock of money, under this situation to much money chases to few goods.
Definition in good market
Inflation is the condition of generalized excess demand in the goods market.
Definition in international market
 Inflation is a fall in the external value of money as measured by foreign exchange rate or by price of gold.
Classification/Types of inflation

 1. Open or suppressed inflation.
2. Creeping/moderate
3. Galloping/hyperinflation
4. Anticipated and unanticipated
5. Demand pull
6. Cost push
7. Administrative inflation

Criteria for classification
1. Working of market
2. Rate of which price are increased
3. Expectation about inflation
4. Causes of inflation
Explanation and definition of demand pull inflation what are its causes and remedies to control it
Definition of demand pull
Demand Pull inflation is actually the
 concept of classical economist. according to them demand pull inflation is a situation when aggregate supply remaining the same and aggregate demand is increased as shown in the diagram explanation in the above diagram

Figure 3.1
Explanation:
In the above diagram AS and AD interest at point E0. At this point level of employment P0 Is YF and level of price is P0. Now, if Aggregate Demand (AD) increase it will be shift upward from AD0 to AD1 and new equilibrium point is E1 level of employment remain same, but price level increase from P0 to P1 due to increase in aggregate demand.
We can use IS-LM approach to explanation of demand pull inflation.

Figure 3.2
Explanation: In the diagram three market equilibrium at point E0 level of employment is YF and price level P0 if money supply increases LM curve shift right down ward new equilibrium level of point E1 level of employment determined by this point is YA which is above full employment level and price determined in the market is 0P1.now it is clear that when money supply increases in the country price level also increase. When price level increased LM1/P0 shift upward left which shows that real purchasing power of peoples decrease and LM1/P1 reach at point EO and this procedure is continuous until it reach at point E3 at this point level of employment is YB which is below the level of full employment price level also increased from 0P1 to 0P3 Smoothly.
Demand pull inflation in Keynesian view
in Keynesian framework increase in demand will not immediately bring an increase in price level but after a certain point man aggregate supply (AS) curve become vertical straight line increase in demand will bring an increase in price level. It will be called demand pull inflation or pure inflation in Keynesian analysis as shown in figure 3.2

Figure 3.3
Explanation:  in this diagram according to Keynesian employment AD1 interest AS curve at point E0 equilibrium level of employment is YE0
and price level is PO if a d curve shift right ward and intersect at point E1 level of employment increase from YE0 To YE1 but price level remain same it is clear that in first part AS curve if AD increase in this part level of employment increase but price level remain constant and there will no inflation in first phase of AS curve
2nd in second phase of AS curve if ad increases and due to this change price also will also change. We call it bottle neck inflation as shown in figure 3.2 above Ad2 shift to right upward and intersect at E2 at this point employment level increase YE1 to YE2 price level goes up P0 to P2 in this part of is AS curve as aggregate demand (AD) increased level of employment and price level will also increase.
According to Keynesian model when we reach in 3rd phase of aggregate supply (AS) curve, The demand pull inflation will create as aggregate demand (AD) increase and aggregate demand (AD) curve will shift upward there will be no change in level of full employment but there will be change in price level increased from P2 to P3 and P4 as aggregate demand (AD) increase continuously
Causes of demand pull inflation
1. Increase in the population
As population of a country increase there will be an increase in the effective demand and due to this increase in effective demand price level will also increase in the market and this demand creates inflation in the country.
2. Increase in government non development expenditure
When Government spends on non-development project there will be no increase in production but supply of money increase in the country and price level has also increase.
3. Deficit financing:
 If central bank adopt the deficit financing policy there is increase in the money supply in a country due to this policy price level goes up in the economy.
4. Increase in circulation of money supply
If circulation of money increase in the country price level will be increased in the economy.
5. Effects of Black Money:
When people invest their black money in the economy the velocity of money increase due to this price level also goes up and it will create inflation in the economy.
6. Demonstration effect
As people increase their expenditure due to demonstration fact demand of goods will be increase and price level will also increase in the country.
7. Increase in foreign remittances
If foreign remittance is increased to a country there will be increase in real purchasing power of the people. The demand for goods will also increase as resulting the price level will be increased.
8. Spend thrift society
If people of the country are spend thrift they purchase more goods and demand of things will be increase due to this change in demand price level will also be increase.
9. Increase in cost of imports
If cost on imports are increased the price of imported goods will also be increased.
10. Inelastic agriculture production
If Agriculture sector yield remain same but demand of goods increase by the people price of goods will also be increased in the country.

Remedies to control demand pull inflation

  • Control on the population of a country.
  • By reducing the circulation of money.
  • By controlling the demonstration effect. 
  • Increase in the production of goods.
  • To control the cost of production.
  • Reduction in the money supply.
  • By controlling the social evil, like monopoly.
  • Control on non-development expenditures of government
Author: Nasir Mehmood Ch                 مصنف: ناصرمحمود چوہدری 
Email: Nasirmehmoodch97@gmail.com

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