Prelims 2021

Q. With reference to Indian economy, demand-pull inflation can be caused/increased by which of the following?

1.Expansionary policies
2.Fiscal stimulus
3.Inflation-indexing of wages
4.Higher purchasing power
5.Rising interest rates

Select the correct answer using the code given below:
a) 1, 2 and 4 only
b) 3, 4 and 5 only
c) 1, 2, 3 and 5 only
d) 1, 2, 3, 4 and 5
Correct Answer: a) 1, 2 and 4 only

Question from UPSC Prelims 2021 GS Paper

Explanation : 

Demand-Pull Inflation and Its Causes

Demand-pull inflation occurs when the demand for goods and services exceeds the supply, leading to an increase in prices. This type of inflation can be influenced by various factors. Let’s examine the options provided:

Expansionary Policies

Expansionary policies, including both monetary and fiscal policies, can lead to demand-pull inflation. When a central bank lowers interest rates or increases the money supply, or when the government increases spending or cuts taxes, it can boost overall demand in the economy, potentially leading to higher prices if supply does not keep up.

Fiscal Stimulus

Fiscal stimulus involves increased government spending or tax cuts designed to stimulate economic growth. This can increase the aggregate demand in the economy, potentially leading to demand-pull inflation if the output does not rise correspondingly.

Inflation-Indexing of Wages

Inflation-indexing of wages means that wages are adjusted based on the rate of inflation. This can contribute to a wage-price spiral, where higher wages lead to higher spending power, which can increase demand and push prices up further. However, it is not a direct cause of demand-pull inflation but rather a response to inflation that can perpetuate the cycle.

Higher Purchasing Power

When consumers have more disposable income or higher purchasing power, they can spend more on goods and services. This increased demand can lead to demand-pull inflation if the supply side of the economy does not expand at the same rate.

Rising Interest Rates

Contrary to expansionary policies, rising interest rates typically reduce borrowing and spending, which can cool down demand. Therefore, rising interest rates are generally used as a tool to combat inflation, not cause it.

Based on the above explanations, the correct answer is “1, 2, and 4 only,” as expansionary policies, fiscal stimulus, and higher purchasing power can all lead to increased demand, which can cause or exacerbate demand-pull inflation. Rising interest rates would not cause demand-pull inflation, and inflation-indexing of wages is more of a response mechanism to inflation rather than a direct cause.

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