Cause and effect

What causes inflation to occur? The popular view among economists is that inflation happens when the country’s overall money supply grows faster than the economy does. The money supply includes cash, credit, loans, mortgages, etc. When the availability of money is too great, it creates a situation that economists refer to as “too much cash chasing too few goods.” Consumer demand (and ability to buy) is greater than supply, so prices go up. This situation is also known as demand-pull inflation.

Inflation can also occur when certain commodities become more limited and more expensive, driving up the prices of all related goods and services. This is called cost-push inflation. Here are a few examples:

• A scarcity of steel pushes up the costs of constructing new buildings, manufacturing new cars, etc.
• A strong labor union negotiates higher salaries for its members, pushing up the costs of the goods their company creates.
• A producer with considerable market power decides to increase its prices, and the competition isn’t strong enough to push them back down. This happened in the 1970s when the Organization of the Petroleum-Exporting Countries (OPEC) increased the price of oil as a form of political protest against the United States. This pushed up the costs of many goods and services in the United States, including gasoline, shipping, land and air travel, etc. To access informative articles, photos, and videos about the 1970s energy crisis, visit this History page Links to an external site..
• Supply shock occurs because of an unexpected event, pushing up costs and prices. For example, suppose that an oil spill destroys a considerable percentage of the lobster population, making lobsters much scarcer this season. This causes lobster dishes to become more expensive for restaurants to make and, therefore, more expensive for customers to buy.