Causes: What will result in inflationary growth?

Hi everyone! We are back today to teach you on what are the causes of inflationary growth!

Inflationary growth occurs due to an overly robust growth in consumption levels, resulting from positivity-driven consumption (C) and investment (I), which outpaces the growth in the productive capacity of an economy. As such, the general price level rises (Figure 1: general price level P changes from P₀ to P₁). This is due to the bigger magnitude of shift in aggregate demand, from AD₀ to AD₁, compared to that in aggregate supply, from SRAS₀ to SRAS₁. While economic growth occurs (real GDP, Q increases from Q₀ to Q₁), general price levels rise too; this is a situation of inflationary growth.

Figure 1: Inflationary Growth

As factors of production deplete, production faces a supply bottleneck - general price levels increase exponentially for every additional unit of production, causing inflationary growth.

Didn't understand that? Now let us explain in simpler, colloquial terms! We have learnt previously in this post http://preview.tinyurl.com/ntctys6 , that inflationary growth occurs when actual growth far exceeds potential growth. Actual economic growth refers to aggregate demand (AD), which can be derived from the formula (C+I+G+X-M), representing consumption levels, investment, government expenditure, exports and imports respectively. Inflationary growth happens when there is a huge rise in consumption, represented by C, causing a huge rise in actual economic growth. However, the productive capacity of the country,represented by aggregate supply, which refers to the countries' potential economic growth, is outpaced greatly by the actual economic growth. Hence, people demand for more goods and there is not enough supply of the goods due to productive capacity not being high enough, resulting in increasing prices of the goods, known as inflation.

Now that you know the cause of inflationary growth, what can YOU, do to stop it? Find out more in the next post!

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