Supply and Demand Indicator
Supply and demand help to understand why stagflation is likely to occur.
After many years, inflation has finally begun to materialize in both established and emerging economies, and as a result, it is currently the topic of discussion for both individuals and politicians throughout the world.
Although inflation is a problem for all economies, how different nations deal with it varies greatly.
Since inflation is produced differently in each nation, location, and industry, its consequences on the financial markets, the economy, interest rates, and the value of the currency must also be assessed differently.
Policymakers in each nation must thus offer unique strategies to deal with it in order to address it.
In general, a decline in supply, or the economy's capacity to produce products and services, as well as an uptick in demand for those same goods and services may contribute to inflation.
Or from a mix of the two, as is the case with the current state of the global economy.
The cessation of commercial activity due to COVID-19 was the primary reason for the decrease in supply, which then resulted in a rise in inflation.
The supply of products and services has decreased globally as a result of supply chain disruption caused by border closures.
Additionally, because of the ongoing lockdowns brought on by the epidemic for roughly two years, there was a reduction in supplies.
In reality, a large number of those who lost their employment as a result of the drastically decreased supply in several job sectors altered their professional focus, while others who were nearing retirement chose early retirement.
Additionally, because of the pandemic, fewer people have migrated in pursuit of employment in various industries and nations, which has reduced their involvement in the labor force in those nations and industries as well.
After Russia invaded Ukraine, the pandemic's unfavorable situation worsened even further because the war severely disrupted supply chains and the flow of goods like oil, gas, agricultural products, wheat, corn, and fertilizers because these two nations produce a sizable portion of the world's supply of these items.
These two nations' curtailment and interruption of the supply chain for basic commodities caused a sharp increase in the price of those items, which in turn increased inflation.
A crucial factor also has to do with the emerging economies' insufficient transition to low inflation and low interest rates over the past few decades.
As a result, the supply chain disruption caused a sharp increase in interest rates, which in turn reduced the production capacity of these nations and decreased their ability to supply goods on global markets.
Growth in Demand
Since the start of the pandemic, economic officials have pursued an expansionary fiscal policy in an effort to help individuals and companies in 2020 and 2021.
Following the epidemic, this approach, along with the capital surplus produced by the decline in investment and consumption, caused a massive increase in demand for products and services.
The loosening of monetary policy, as several central banks decreased interest rates to promote economic development, has also contributed to the rise in demand.
Low borrowing rates have, in fact, been a key factor in boosting demand in recent years.
Calculating growth and prices
Now let's examine how the two aforementioned variables affected pricing and market and economy growth using an illustration of the supply and demand economic model.
The supply and demand curves for the entire economy are depicted in the image below (GDP).
Because higher prices discourage spending and output while lower prices promote it, the demand curve slopes downward.
Because more production is encouraged by higher prices and less output is discouraged by lower prices, the supply curve is upward-sloping.
The horizontal axis represents real GDP, indicating the expansion of the economy, while the vertical axis measures price level, indicating an increase or decrease in inflation.
The demand curve on the right side of the figure changed from 2019 to 2022 (solid line to dotted line), indicating an increase in demand (represented in green).
If an increase in supply were to coincide with this movement of the demand curve to the right side of the figure, then the supply curve (shown in orange) would similarly shift to the right side of the diagram, indicating a rise in real GDP.
That, if the dotted line outlining the Optimum Supply Curve had moved to the right (shown in brown).
This, however, did not take place. Instead, when supply declined due to the causes mentioned above, the supply curve (shown in orange) moved to the left from 2019 (solid line) to 2022 (dashed line), which led to an increase in the price level, inflation, and a reduction in real GDP.
Approaching stagflation
Every economy in the world is negatively affected by the supply shock.
The nations of Europe will have the most difficulty providing Ukraine with commodities as a result of the conflict there.
In addition, developing nations will probably have a food crisis as a result of the interruption of the supply chain, and the cost of borrowing will continue to be high.
The shift of energy from fossil fuels to sustainable energy will be the largest challenge for industrialized economies, particularly in Europe.
This will take time, though, and increase the cost of the metals and minerals that are needed for the changeover.
Brexit will hinder economic development and raise inflation in the UK by imposing more prices and trade restrictions.
The supply curve will move to the left if there is a potential drop in Russian energy supplies over the upcoming winter.
This has demand-reducing consequences and moves the demand curve to the left along with the upcoming tightening of monetary policy by central banks (tending towards the 2019 level).
While inflation is still high, this combination may put pressure on real GDP. In such a case, stagflation circumstances are unavoidable and will likely continue, at least in the short term.
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