Answer to Question #265327 in Macroeconomics for Situ

Question

Consider the following scenarios, state and explain the type of inflation it is associated with.

i. If inflation increases because of the large increase in the price of oil.

ii. If inflation increases after a large increase in government spending.

Answer 1

Solution:

i.). This is an example of cost-plus inflation.

Cost-push Inflation happens when the cost of production rises. Increases in input prices (labor, raw materials, etc.) raise the price of the product. Therefore, increases in the raw materials for oil production results in a large increase in the price of oil.

 

ii.). This is an example of demand-pull inflation.

Demand-pull Inflation occurs when the demand for goods or services exceeds the capacity of production. Price increases as a result of the difference between demand and supply. Increased government spending will increase consumer spending which can result in high demand for products and services. This will, therefore, lead to scarcity of most goods and inflation will follow due to higher prices brought about by demand-pull inflation.