Business, 17.01.2020 04:31 mmoore36

What theory of inflation is at work when producers raise prices in order to meet increased costs?
the quantity theory
the cost-push theory
the demand-pull theory
the wage-price spiral theory

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The theory of inflation that is at work when producers raise prices in order to meet increased costs is the cost-push inflation theory.

Explanation:

The price of goods and services in a conventional market usually fluctuates due to various factors. An attempt to understand these factors that cause a change in the price of goods has been made by the use of different theories. These theories are further explained below;

1. The quantity theory: the quantity theory forms a relationship between the supply of money and the price of goods. The theory stipulates that the amount of money in supply is nearly proportional to the price level og goods and services. The equation for elaborating this relationship was formulated by economist Irving Fisher as shown;

M×V=P×T

where;

M=money supply

V=velocity of money

P=average price level

T=volume of transactions in the economy

This generally means that an increase in the supply of money in the economy generally causes inflation, thus the price level also goes up. The opposite is also true, a reduction in the money supply causes deflation, thus the price level also reduces.

2. Cost-push theory: the cost push theory states that an increase in the cost of doing business causes an increase in the price. The cost of doing business in this case is usually an increase in the cost of raw materials and wages which increases the cost of production. When the cost of production increases, the producers increase the price of the product to account for the increased cost. This increase in price is what is termed as inflation.

3. Demand-pull theory: this theory relates the demand and the price level. It states that an increase in the demand causes an upward pull to the price. This often occurs when the demand surpasses the supply.

4. Wage-price spiral theory: this theory is used to form a relationship between the wage and the price. It stipulates that when the wage is increased, more people are able to afford most goods and services thus the demand increases. This increased demand causes an increase in the price.

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What theory of inflation is at work when producers raise prices in order to meet increased costs?

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