What is inflation?

It is the sustained increase in the general price level. There are two types of inflation, cost push inflation and demand pull inflation. Cost push inflation is when costs increase so much that firms increase their prices as a result to keep the same profit margins. Demand pull inflation is when demand is high and therefore the price increases until a new equilibrium is found. Demand pull inflation is more likely to occur when cyclical unemployment is low.

It is important to remember that the causes of each are different. With one being more related to the supply side and the other to the demand side. The main causes of demand pull inflation are depreciation of the exchange rate, fast growth abroad, monetary stimulus and expansionary fiscal policies. The main causes of cost push inflation are: raw material costs, labour costs, expectation, higher indirect taxes, monopolies and a fall in the exchange rate.