cuts) resulted in greater than intended an expansionary shock to the system: excess aggregate demand, creating and inflationary gap. Wages rose faster than productivity, as firms rushed to meet the demand and produce more at higher prices – this caused costs to rise, and then prices had to rise again: an inflationary spiral. 2) Cost Push Inflation An increased cost to suppliers (not caused by excess demand) means that they raise their prices in order to try and retain the same profit margins. When real prices become high, people start to demand higher incomes. Sometimes firms further increase prices in order to cover their new higher wage costs. Prices get higher again, and so people again demand more wages. When this happens repeatedly, it can lead to another inflationary spiral, and it is what happened to the UK economy in the late 1970’s.In that case, OPEC rapidly and greatly increased the price of crude oil. To begin with, it was only in response to the falling value of the US dollar, but on the first of April 1979, prices went up by 14.5% (See appendix), and then later on that year they were raised by 15%. In total, this meant that prices increased from around US$2 per barrel in 1970, to just under $40 in early 1980, with most of these increases having taken place in only around eighteen months. This meant that suddenly costs for almost all sectors of all goods and services markets had risen drastically, as fuel costs are one of the most necessary and basic types: nothing can be produced or transported without power or fuel. This meant that prices had to rise regardless of the level of demand as firms tried to cover increased costs while keeping normal profit levels. ( See diagrams: Appendix 1)Another factor in the high level of inflation in the ‘70’s – it reached almost 25% in ’75 (see appendix 2) – was the power of the Trade Unions. Because of cl...
