Inflation in an under-developed economy generally sets in
- Before the point of full employment
- After the point of full employment
- At the point of full employment level
- All of the above
Correct Answer: Before the point of full employment
Answer Explanation
Under-developed economies often experience inflation before full employment is reached. This phenomenon can be attributed to a combination of factors that contribute to inflationary pressures.
Economic diversification, limited industrialization, and limited technological advancements are common challenges in underdeveloped economies. The economy may not be able to generate enough demand for goods and services to reach full employment due to structural issues, a lack of skilled labor, and underutilization of resources.
There are several factors that can contribute to inflation taking root before full employment in this context:
Demand Pull Inflation
As aggregate demand exceeds supply in underdeveloped economies due to which prices increase. As a result of rising income and increased access to credit, consumers and businesses compete for limited resources. Demand-pull inflation occurs when there is a gap between demand and supply, resulting in price increases before full employment is achieved.
Supply-Side Constraints:
Poor infrastructure, limited technological capabilities, and inefficient production processes are common structural bottlenecks in underdeveloped economies. In such cases, inflation may set in before full employment is achieved because the economy is unable to respond to increased demand due to these constraints.
Economic Factors:
Underdeveloped financial markets and informal economic activities may limit the effectiveness of monetary policy tools in underdeveloped economies. When full employment is reached, changes in monetary policy may not have an immediate impact on controlling inflation.
Why the other options are not correct
b. After the point of full employment:
It is possible for inflation to occur after full employment, but many underdeveloped economies struggle to reach full employment in the first place. In addition to structural issues, skill gaps, and underutilization of resources, this option is less likely for the economy to achieve full employment.
c. At the point of full employment level:
While inflation can occur at full employment, it is less common in underdeveloped economies when it occurs at this level. As a result, inflation is more likely to develop before full employment in such economies because they are characterized by persistent underemployment and underutilization of resources.
d. All of the above:
Selecting “All of the above” is not accurate since inflation generally occurs before full employment in underdeveloped economies. There are factors that contribute to inflation in these economies, which align with the scenario in which inflation emerges before full employment is reached.
Conclusion
In under-developed economies, inflation is more likely to occur before full employment is reached. Inflation can emerge as the economy approaches full employment due to a combination of demand-pull inflation, supply-side constraints, and limitations in monetary policy effectiveness. If policymakers are to manage inflationary pressures in underdeveloped economies, they must understand these dynamics.