Factors Causing Decrease in Supply
Various factors responsible for reducing the supply of goods and services in the economy are given below:
1. Scarcity of Factors of Production:
On the supply side, inflation may occur due to the scarcity of factors of production, such as, labour, capital equipment, raw materials, etc. These shortages are bound to reduce the production of goods and service for consumption purposes and thereby the price level.
At a tune of shortages and rising prices, there is a tendency on the part of the traders and businessmen to hoard essential goods for earning profits in future. This causes scarcity and rise in prices of these goods in the market.
3. Trade Union Activities:
Trade union activities are responsible for inflationary pressures in two ways
(a) Trade union activities (i.e. strikes) often lead to stoppage of work, decline in production, and rise in prices.
(b) If trade unions succeed hi raising wages of the workers more than their productivity, this will push up the cost of production, and lead the producers to raise the prices of their products.
4. Natural Calamities:
Natural calamities also create inflationary conditions by reducing the production in the economy. Floods and draughts adversely affect the supply of products and raise their prices.
5. Increase in Exports:
An increase in exports reduces the stock of goods available for domestic consumption. This creates a situation of shortages in the economy-giving rise to inflationary pressures.
6. Law of Diminishing Returns:
The law of diminishing returns operates when production in increased by employing more and more variable factors with fixed factors and given technology. As a result of this law, the cot per unit of production increases, thus leading to a rise in the prices of production.
During the war period, economic resources are diverted to the production of war materials. This reduces the normal supply of goods and services for civilian consumption and this leads to the rise in the price level.
8. International Causes:
In modern times a major cause of inflationary rise in prices in most of the countries is the international rise in the prices of basic materials (e.g. petrol) used in almost all the industrial materials.