What is Inflation – Inflation is a situation in economy where, there is more money chasing less of goods and services. In other words it means there is more supply or availability of money in the economy and there are less goods and services to buy with that increased money. Thus goods and services command higher price than actual as more people are willing to pay a higher value to buy the same goods. In this inflationary situation, there is no real growth in the output of the economy per sector. It’s simply more money chasing few goods and services.

THE BASIC TYPES OF INFLATION

Demand-Pull Inflation
Demand-pull inflation places responsibility for inflation squarely on the shoulders of increases in aggregate demand. This type of inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output that the economy is capable of producing.

• In terms of the simple production possibilities analysis, demand-pull inflation results when the economy bumps against, and tries to go beyond, the production possibilities frontier. Then end result is inflation.

• In more elaborate aggregate market analysis, demand-pull inflation results when aggregate demand increases beyond aggregate supply creating economy-wide shortages. As with market shortages, the price (or price level) rises. Then end result is inflation.

Cost-Push Inflation
Cost-push inflation places responsibility for inflation directly on the shoulders of decreases in aggregate supply that result from increase in production cost. This type of inflation occurs when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases.

• In terms of the production possibilities analysis, this means that the production possibilities frontier is shrinking closer to the origin, causing it to bump down against the aggregate demand. Then end result is inflation.

• In the aggregate market analysis, aggregate supply decreases to less than aggregate demand creating economy-wide shortages. As with any market shortages, the price (price level) rises. Then end result is inflation.

Inflation Rate = (Current year's price index - Last year's price index) / Last year's price index