"Inflation" is theterm used to describe a rise in the general price level of goods and services.Note that individual price increases, for example due to seasonal shortages offood,are not classified as inflation. There are three situations which can resultin inflation.

The first is the one in whichthe demand for goods and services(and the money available to purchase them)exceeds the supply available. (51) There may be a large supply of moneyavailable for one or more of several reasons because government spending isrelatively high;or because credit is easily available; or because people haverelatively high disposable income (e.g. incomes after tax plus transfers, suchas children's allowances). When customers want to spend money on goods andservices but there are not enough of them to satisfy the demand，prices riseaccordingly. This is often referred to as "demand-pull inflation".

The second situation whichcauses inflation is the one in which production costs are rising. Productioncosts include raw materials, energy, and wages. (52) When workers find theycannot afford the goods and services they need owing to the fact that pricesare too high,they seek wage increases. Sometimes increased production costsare absorbed in increased productivity or a reduction in profits so that theyare not passed on in higher prices. More usually, however, they are not and,hence, prices rise. This is often referred to as "cost-pushinflation". (53) These two causes of inflation are often interrelatedso that the one situation leads to the other which in turn leads to arecurrence of the first situation. This chain of cause and effect is calledan "inflationary spiral".

A third cause of inflation maybe government policy. (54) Governments can affect the level of prices bycontrolling or regulating them, or by reducing taxes on goods and services and,accordingly, keeping prices down. Alternately, if a government does notregulate prices or if it imposes higher taxes (such as VAT) it may push pricesup. Governments also occasionally attempt to control the level of wageincreases and, hence, keep those production costs down. Lastly, as mentionedearlier, some people think that higher prices are often due to high governmentspending.

Inflation has severalconsequences, all of which are bad.

First, because the real valueof money tends to decline, lenders of money, such as banks,are less willing tolend or are willing to do so only at higher interest rates. This makesborrowing more expensive, and thus may cause prices to rise even further, owingto the increased cost of borrowing.

Second, there are many groupsof people whose incomes are fixed or whose incomes tend to rise slowly andinfrequently. In a period of inflation the living standards of these peoplefall and, as a result, they suffer hardship. Old age pensioners are examples ofone of these groups.

Third, when people see thevalue of money being eroded, they are less willing to save. (55)Accordingly, there is less money available for investment in the new equipmentwhich is frequently necessary if productivity is to increase. It may bemore difficult, therefore, to absorb increased production costs. Consequen,prices continue to rise.

 
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