What Causes Inflation?

1. Demand-Pull

This is one of the primary causes of inflation, where purchasing a specific good or service increases and decreases its availability. It creates a substantial gap between its demand and supply, leading to a hike in its price.

Let’s understand it using an example. For instance, there is a sudden hype regarding a food item owing to increased consumption and affordable rates. Thus a lot of people would like to purchase and consume it daily.

It might lead to a massive increase in demand for the food item, surpassing its availability rate. In such situations, its cost considerably increases so that it is only available to a small group of people and not everyone. This increase in price leads to inflation.

2. Devaluation

This refers to a fall in the value of one country's currency compared to others. Since foreign currencies are the basis of international trade, they can affect product prices. It will eventually increase the price of products in the country of import.

For example, if the value of rupees falls below dollars, Indian traders will have to pay more for a particular item. It will subsequently increase the price of that item in India, leading to inflation.

Additionally, the demand for Indian goods will increase in the U.S. due to their lower price. Also, due to an increased price of foreign goods, the need for Indian products will increase in India itself. This leads to a shortage in the supply of that product and a rise in its price.

3. Cost-Push

This refers to scenarios in which the production cost of goods increases considerably, leading to a hike in the product price. The production cost includes the money involved in purchasing raw materials, machinery and labour.

For instance, if you consider a cotton dress, the primary raw material you will require is cotton. However, to turn that cotton into a dress, you might need expensive machinery and workers who will turn the cotton into cloth. Then there will be designers weaving this cloth into an attractive dress.

So, if the availability of cotton decreases or the wages of workers increase, or the machines become costlier, the cost of production of that dress increases. It leads to a subsequent increase in the price of the dress to maintain a particular profit margin. This substantial hike in price leads to inflation. 

In such instances, only a few people can afford this expensive dress. However, in certain circumstances, cost-push inflation becomes more prominent and widespread. These include natural disasters like cyclones and floods that impact significantly more significant portions of the economy.

4. Rising Wages

5. Inflation Expectations

People believe that the price of services and goods will shoot up prominently in due course of time. Accordingly, businesses decide the cost of their products. With a similar view, workers also decide their wages so that they have sufficient money with them during inflation.

However, people must believe that inflation will stabilise and return to normal soon. So, it becomes essential to behave in a manner to manifest stabilisation and lower inflation.

These are some of the root causes of inflation that can lead to severe consequences if not controlled correctly. However, you can take several measures to increase your finances and protect yourself from its damaging effects.