Which one of the following situations can lead to inflation?

Rapid growth of aggregate demand outweighing supply

Sluggish growth of aggregate demand

Reduction in the money supply

Higher levels of unemployment

Answer is Right!

Answer is Wrong!

This question was previously asked in

UPSC CDS-1 – 2023

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The correct answer is A) Rapid growth of aggregate demand outweighing supply. Inflation is a general increase in the price level. When the total demand for goods and services in an economy (aggregate demand) grows faster than the economy’s ability to produce those goods and services (aggregate supply), it leads to demand-pull inflation as consumers bid up prices.

– Inflation can be caused by factors affecting demand (demand-pull inflation) or factors affecting supply (cost-push inflation).
– Rapid growth of aggregate demand relative to supply creates upward pressure on prices.
– Sluggish demand growth typically leads to disinflation or deflation.
– Reduction in money supply is a monetary policy tool usually used to *combat* inflation by reducing aggregate demand.
– Higher levels of unemployment are usually associated with slack in the economy and low demand, which reduces inflationary pressure.

Other causes of inflation include increases in the cost of production (cost-push inflation), expectations of future inflation, and structural rigidities in the economy. However, excess aggregate demand is a fundamental driver of inflation.

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