As we can see in the inflation article, this is a generalized increase in the prices of goods and services during a given period of time. This price increase can occur for several reasons.
The price system supposes a very complex system of interrelations. The quantitative theory of money tries to explain why these price variations occur. Given a large number of variables that affect prices, it is difficult to list them all. However, in this article, we are going to expose the big factors that affect prices and inflation.
Individuals show their needs and help to make the necessary adjustments in supply and demand. Whether the demand increases, or whether the costs of raw materials increase, it affects the prices that the consumer ultimately has to pay.
One of the functions of the prices is to allow the buyers to indicate the quantity of product they wish to buy according to the price of the market and the entrepreneurs to determine the quantity of product they wish to sell at each price. Taking these functions into account, it is important to know what affects the price changes.
Here are the most important causes of inflation:
- Inflation by demand: Appears when the general demand increases and the supply of the productive sector are not able to cope with that demand, which is why prices rise. For example, when a clothing brand becomes fashionable, its prices usually end up going up.
- Inflation costs: Occurs when production costs increase, either because they increase the prices of raw materials, labour or because they raise taxes, which causes producers to raise the final price of the product or service to compensate for the said increase.
- Self-built inflation: It arises from expectations of producers that prices will rise in the future and seek to anticipate them by raising prices first, causing that in the end their predictions are met for having raised prices.
- Because of the increase in the monetary base: when the monetary base increases (amount of money in an economy) it causes the demand (D) of products to increase faster than the supply of the goods and services of the supply (S) and this causes prices to increase (P). In the following formula, we see how when demand has a greater increase in relation to the supply of goods, prices go up.
This situation was experienced for the first time in Spain in the sixteenth and seventeenth centuries when ships with precious metals that were sent to the Iberian peninsula from America, instead of causing it to greatly increase the wealth of Spain caused that the prices of all the goods and services of the peninsula. These facts were recorded by the first economists in history, among them Martín de Azpilicueta, precursor of the quantitative theory of money, belonging to the Salamanca School, where the first economic studies were carried out, long before the classical school and Adam Smith wrote his famous book “The Wealth of Nations” in 1776.
The first three causes of inflation are explained by the Keynesian theory, while the latter comes from the monetarists and the quantitative theory of money.