Inflation Flashcards
Demand theories of inflation
It argues that an increase in PL is caused primarily by excess demand. Where demand exceeds supply, price rises as consumers would rather pay more than leave empty handed.
The Quantity Theory of Money
A theory that states that money supply and price level in an economy are directly proportional e.g. an increase in money supply increases price level.
QTM summary
Often seen as too much money for too few goods. If your money doubled you would want to consume twice as much but if supply hasnt doubled, youll face competition for goods so price will increase.
The fisher equation for QTM
Money supply x Velocity of circulation = Price level x quantity of output (M x V=P x Q). To explain inflation it assumes V and Q are constant so an increase in M causes an increase in P
Keynesians rejection of QTM
-V is not constant as assumed
-M can increase without P increasing if there is spare capacity
-Increased P causes increased M rather than the other way around
Velocity of circulation
V represents how often money is spent within an economy e.g do people spend there money or hold onto it
V is not constant
Monetarists believe it is irrational to hold onto money with low interest rates an it should be spent on things like shares (V remains constant). Keynesians believe its sometimes rational to hold onto money instead of risk loss when spending on shares. This causes V to fluctuate
M can increase without P increasing
Keynesians believe that if there is unemployment/spare capacity in the economy, an increase in M can cause an increase in real income and national income. Cost push inflation is minimal as there’s no shortage of labour and demand pull inflation is not a problem if output can grow to meet increased demand.
Increased P causes increased M rather than the other way around
If prices rise, the money supply needs to increase so that the current level of economic activity is maintained. Strict control of money supply can choke an economy and cause unemployment.
Keynesian demand pull theory
A theory that argues that the cause of the excess demand is the behaviour of economic agents (people) rather that the volume of cash in circulation. The excess demand could arise from an increase in the components of AD.
Keynesian cost push theory
It explains inflation as a leftward movement of the SRAS curve: when a firms costs increases the quantity of goods supplied at a given price level falls. A new equilibrium is found at a higher price level and lower output.
Cost push theories
They are often wage push theories as labour costs are a major factor for most firms but commodity prices (such as oil prices) can have a similar effect
