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Q103 (CDS-I/2023) Economy › Money, Banking & Inflation › Inflation concepts Answer Verified

Which one of the following situations can lead to inflation?

Result
Your answer: —  ·  Correct: A
Explanation

Inflation is primarily driven by two mechanisms: demand-pull and cost-push. Demand-pull inflation occurs when the total demand for goods and services (aggregate demand) increases to exceed the economy's sustainable supply capacity [6]. This situation is often described as "too much money chasing too few goods," where excessive demand in an expanding economy forces prices upward [5]. Conversely, sluggish growth in aggregate demand or a reduction in the money supply typically leads to deflationary pressures or recession rather than inflation [5]. Higher levels of unemployment are generally associated with lower inflation according to the Phillips curve, as inflation tends to decrease when unemployment is above the Non-Accelerating Inflation Rate of Unemployment (NAIRU) [7]. Therefore, the rapid growth of aggregate demand outweighing supply is the situation that leads to inflation [8].

Sources

  1. [1] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > There are mainly two causes of inflation: > p. 112
  2. [6] https://www.investopedia.com/terms/d/demandpullinflation.asp
  3. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > CHAPTER SUMMARY > p. 77
  4. [5] https://www.rba.gov.au/education/resources/explainers/causes-of-inflation.html
  5. [3] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 4: Inflation > Deflation > p. 74
  6. [7] https://www.congress.gov/crs-product/R47273
  7. [8] https://www.sciencedirect.com/science/article/pii/S1090944324000516
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