Question

Explain the theories of Inflation and what is stagflation?

Answer 1

Market-Power Theory of Inflation- In an economy, if a single or a group of sellers agree together on a new price that is different from the competitive price, then the value is called the cost of market power. These organizations keep prices at the rate at which they can gain maximum profit without having to worry about customer purchasing power. For example, in India, onion prices have been very high in the past few years. The steep price of onions was the result of the onion producers ' group action. In such a scenario, the onion intake was decreased by people in middle and low income classes. Onion farmers, however, are receiving high profits from the higher income community. According to the advanced version of inflation market power theory, even if demand does not increase, oligopolists may raise the price to any amount. The increase in price levels was due to higher salaries in the oligopolistic sector (because of trade unions).

Conventional Demand-Pull Inflation- Deflation's market power theory is one extreme end of deflation. Inflation occurs even when there is no excess demand, according to this concept. On the other hand, conventional demand-pull theorists believed that excess aggregate demand over aggregate supply was the only cause of inflation. In the state of full employment equilibrium, inflation is unavoidable as demand increases. In fact, the economy achieves its peak production capacity in the state of full employment.

Structural Theories of Inflation- There is a middle group of economists called structural economists apart from the two extreme ends described in the above. Market power is one of the factors causing inflation, according to the systemic theory of inflation, but it is not the only one. Structural theory supporters believed that inflation arises because of structural disadvantages in the county or some of the institutional characteristics of the business environment.

Stagflation incorporates slow economic growth, high unemployment, and high inflation. It is an unusual situation, because inflation in a weak economy is not expected to occur. Slow growth avoids inflation in a normal market economy. As a result, consumer demand drops enough to avoid rising prices. Stagflation may occur only if government policies interfere with the normal functioning of the economy. Stagflation occurs when the money supply is expanded by government or central banks while at the same time restricting supply. The most popular culprit is when money is issued by the state. It can also happen if credit is generated by monetary policies of a central bank. Both are increasing the supply of money and generating inflation.