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The economy generally has 4 or sometimes 5 stages.

First one being the boom of


economy or
growth phase, where there is lot of money in the market and with the people. The
purchasing power goes up, product demand goes up, production goes up, and revenues
and
profits go up. But this cannot last forever. Due to increased money flow and
spending,
prices go up and this leads to inflation. This is the second stage. There is
relative
slowdown in economy. Prices go up so people have less to spend and and to save.
Demand
goes down, production and earnings go down. The economy may take a rebound from
here or
go further into recession. This is the third stage where situations starts to
actually
worsen. Increased prices, less earning, demand goes down, revenues and profits go
down.
Companies and organizations start downsizing and cost cutting. This leads to
unemployment
and further decreases the flow of money into the system. This kind of runs into
visicious
circle. People dont want to take risk of investing and starting new businesses.
Foriegn
investment in reduced. Even worse form of recession is depression. But as with
boom, even
recession and depression cannot last forever, and the economy starts to take a
turn, and
leads to recovery. Recovery is the fourth stage of economy. Though there is no
fixed time
limit before recession or inflations turns to recovery, and recession sometimes
lasts
longer than boom. In recovery, situation starts to improve. Prices ease, money
starts to
flow. New investments comes in and finally recovery leads to boom in economy
which was

the first stage.

INFLATION CAUSES

There are many causes for inflation, depending on a number of factors. For
example,
inflation can happen when governments print an excess of money to deal with a
crisis.
As a result, prices end up rising at an extremely high speed to keep up with the
currency
surplus. This is called the demand-pull, in which prices are forced upwards
because of a

high demand.

Another common cause of inflation is a rise in production costs, which leads to an


increase in the price of the final product. For example, if raw materials increase
in price, this leads to the cost of production increasing, which in turn leads to

the company increasing prices to maintain steady profits. Rising labor costs can
also
lead to inflation. As workers demand wage increases, companies usually chose to
pass
on those costs to their customers.

Inflation can also be caused by international lending and national debts. As


nations
borrow money, they have to deal with interests, which in the end cause prices to
rise
as a way of keeping up with their debts. A deep drop of the exchange rate can
also
result in inflation, as governments will have to deal with differences in the
import/
export level.

Cost Push Inflation

Cost-push inflation occurs when businesses respond to rising production costs, by


raising
prices in order to maintain their profit margins. There are many reasons why
costs might
rise:

Rising imported raw materials costs perhaps caused by inflation in countries that
are
heavily dependent on exports of these commodities or alternatively by a fall in
the value
of the pound in the foreign exchange markets which increases the UK price of
imported
inputs. A good example of cost push inflation was the decision by British Gas and
other
energy suppliers to raise substantially the prices for gas and electricity that it
charges
to domestic and industrial consumers at various points during 2005 and 2006.

Rising labour costs - caused by wage increases which exceed any improvement in
productivity. This cause is important in those industries which are �labour-
intensive�.
Firms may decide not to pass these higher costs onto their customers (they may be
able to
achieve some cost savings in other areas of the business) but in the long run,
wage
inflation tends to move closely with price inflation because there are limits to
the
extent to which any business can absorb higher wage expenses.

Higher indirect taxes imposed by the government � for example a rise in the rate
of
excise duty on alcohol and cigarettes, an increase in fuel duties or perhaps a
rise
in the standard rate of Value Added Tax or an extension to the range of products
to
which VAT is applied. These taxes are levied on producers (suppliers) who,
depending
on the price elasticity of demand and supply for their products, can opt to pass
on
the burden of the tax onto consumers. For example, if the government was to
choose to
levy a new tax on aviation fuel, then this would contribute to a rise in cost-push
inflation.

Cost-push inflation can be illustrated by an inward shift of the short run


aggregate
supply curve. This is shown in the diagram below. Ceteris paribus, a fall in SRAS

causes a contraction of real national output together with a rise in the general
level
of prices.

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