DEMAND PULL INFLATION THEORY

• THEORIES OF INFLATION PART 1
• MACRO ECONOMICS
• DEMAND PULL INFLATION
  
  
• DEMAND PULL INFLATION

1. IT IS THE OLDEST THEORY OF INFLATION. ALSO CALLED THE FIRST GENERATION THEORY WHICH WAS PREVALENT BEFORE 1970. MOST OF THE ECONOMISTS AGREE THAT INFLATION IS DEMAND PULL PHENOMENON, CONTINUOUS PRICE RISE TAKE PLACE DUE TO RISING DEMAND OVER AVAILABLE SUPPLY OF OUTPUT.

2. INFLATION REFERS TO SITUATION IN WHICH AGGREGATE DEMAND AT THE EXISTING PRICE LEVEL FAR EXCESS AGGREGATE SUPPLY OF GOODS AND SERVICES. INFLATION ARISES DUE TO EXCESSIVE DEMAND.
3. SHAPIRO” ACCORDING TO DEMAND PULL INFLATION,THE GENERAL PRICE LEVEL RISES BECAUSE THE DEMAND FOR GOODS AND SERVICES EXCEEDS THE SUPPLY AVAILABLE AT EXISTING RATES.

• DEMAND PULL INFLATION
• DIAGRAM

• EXPLANATION
• WHEN DEMAND INCREASES FROM D1 TO D2 AND THEN D3 AND THEN D4. PRICE INCREASE FROM P1 TO P2, THEN P3 AND P4. KNOWN AS DEMAND PULL INFLATION. WHEN DEMAND RISES FROM D1 TO D2, AND THEN D3 THEN ALONG WITH PRICE RISE PRODUCTION ALSO INCREASES. SUCH A PRICE RISE IS KNOWN AS SEMI INFLATION, BUT AFTER REACHING FULL INFLATION ANY INCREASE BEYOND DEMAND LEADS ONLY TO PRICE RISE. IT IS TRUE INFLATION BECAUSE IT IS NOT FOLLOWED BY INCREASE IN PRODUCTION.
•  MAIN THEORIES OF DEMAND PULL INFLATION

1. QUANTITY THEORY OF MONEY: AFTER FULL EMPLOYMENT INCREASES QUANTITY OF MONEY LEADS TO RISE IN PRICE LEVEL. QUANTITY OF MONEY IS IDENTIFIED AS SOLE CAUSE OF INFLATION.
2. KEYNESIAN THEORY:ACCORDING TO KEYNES WHEN AD EXCEEDS AS,THE PRICE BEGIN TO RISE. AD=C+I WHEN CONSUMPTION EXPENDITURE OR INVESTMENT OR BOTH RISE THERE IS TENDENCY  FOR THE PRICE RISE
3. HANSEN’S EXCESS THEORY OF DEMAND: HANSEN DEVELOPED A NEW DEMAND INFLATION MODEL IN HIS BOOK,” A STUDY IN THE THEORY OF INFLATION IN 1950. IT IS CONSIDERED TO BE SUPERIOR THAN KEYNESIAN. ACCORDING TO HANSEN INFLATION ARISES DUE TO EXCESS DEMAND FOR GOODS (GOOD GAP) AND EXCESS DEMAND FOR FACTORS( FACTOR GAP) FOR FULL INFLATION THERE MUST BE BOTH GOODS AND FACTOR GAP.

• THE TRADITIONAL QUNATITY THEORY OF INFLATION
• THE QUANTITY THEORY OF MONEY IS ONE OF THE OLDEST THEORY IN THE ECONOMICS THAT CONSTITUTE THE BASIS OF INFLATION. IT ASSUMES THAT THERE IS STABLE AND PROPORTIONAL RELATIONSHIP BETWEEN CHANGES IN THE MONEY SUPPLY AND THE PRICE LEVEL. THE THEORY IS BASED ON
• MV=PT
• M= MONEY SUPPLY
• V=VELOCITY OF MONEY
• P= AVERAGE PRICE
• T=TOTAL NUMBER OF TRANSACTIONS
• THIS THEORY REVEALS THAT AT FULL EMPLOYMENT LEVEL IN THE LONG RUN AS QUANTITY OF MONEY INCREASES PRICE LEVEL ALSO INCREASES AND IT IS BASED ON THE ASSUMPTION THAT MONEY IS MEDIUM OF EXCHANGE
• INFLATIONARY GAP
• KEYNES IN HIS ARTICLE “ HOW TO PAY FOR WAR(1940) EXPLAINED DEMAND PULL INFLATION IN THE FORM OF INFLATIONARY GAP.THE CONCEPT OF INFLATIONARY GAP REFERS TO THE EXCESS OF ANTICIPATED EXPENDITURE OVER THE AVAILABLE OUTPUT AT THE BASE PRICES.DURING WAR TIME AS INCOME OF THE PEOPLE RISES THEY WANT TO SPEND ON CONSUMPTION GOODS BUT THERE IS FULL EMPLOYMENT SO SUPPLY CAN NO BE      INCREASED,
• DIFFERENCE BETWEEN THE QUANTITY OF MONEY TO BE SPENT ON CONSUMPTION GOODS AND THE ACTUAL AVAILABILITY OF SUCH GOODS IS CALLED INFLATIONARY GAP.
• THE EXPENDITURE IS DETERMINED BY CURRENT INCOME AS WELL EXPECTATION OF FUTURE INCOME. THE SUPPLY OF GOODS IS DEPENDENT UPON THE LEVEL OF EMPLOYMENT AND STATE OF TECHNOLOGY.
• KURIHARA “ AN EXCESS OF ANTICIPATED EXPENDITURE OVER AVAILABLE OUTPUT AT BASE PRICES IS CALLED INFLATIONARY GAP.
• EXPLANATION
• 
• INFLATIONARY GAP

• EXPLANATION
• OY 1 LEVEL OF INCOME IS FULL EMPLOYMENT LEVEL. AD(C+I+G)  WHEN INCREASES TO AD1 AT FULL EMPLOYMENT LEVEL. DEMAND IS FY1 BUT OUTPUT IS EYA SO AD IS MORE THAN AS THERE IS INFLATIONARY GAP OF EF. IF INCOME OR OUTPUT INCREASES TO OY2 THEN EQUILIBRIUM WILL BE ESTABLISHED AT E1 THEN THE INFLATIONARY GAP IS PLUGGED.
• CAUSES OF INFLATIONARY GAP
• WHEN QUANTITY OF MONEY INCREASES DUE TO WHICH RATE OF INTEREST FALLS SO THAT INVESTMENT INCREASES SO THERE IS EXCESS DEMAND . IF QUANTITY OF MONEY REMAINS THE SAME INCREASE IN THE PROFITABILITY OF INVESTMENT MAY ALSO CREATES EXCESS DEMAND.
• HOW CAN INFLATIONARY GAP CAN BE REDUCED:-

1. BY INCREASING IN SAVING BUT IT MAY LEAD TO DEFLATION TENDENCIES
2. RAISE THE VALUE OF OUTPUT TO MATCH THE DISPOSABLE INCOME
3. IN THE SHORT RUN OUTPUT CAN NOT BE INCREASES BECAUSE FACTORS ARE ALREADY FULLY EMPLOYED SO THE INFLATIONARY GAP CAN BE REDUCED BY INCREASING TAXES AND REDUCING EXPENDITURE. MONETARY POLICY CAN BE USED TO REDUCE THE STOCK OF MONEY BUT KEYNES WAS NOT IN FAVOR OF MONETARY POLICY.