MTTC 103 Elementary Practice

What factors are most likely to contribute to inflation?

1. High interest rates and a low amount of printed currency

2. High unemployment rates

3. A decrease in supply and a low amount of printed currency

4. A decrease in supply and a large amount of printed currency

The correct answer is: A decrease in supply and a large amount of printed currency

Inflation is primarily influenced by the relationship between the supply of money and the availability of goods and services in an economy. When there is a decrease in supply of goods and services, while at the same time there is an increase in the amount of printed currency or money supply, it leads to more money chasing fewer goods. This imbalance typically drives prices upward, resulting in inflation. In this context, a decrease in supply can occur due to various factors such as supply chain disruptions, natural disasters, or declines in production capabilities. When the central bank or government increases the money supply—whether through policies like quantitative easing or direct currency printing—consumers and businesses have more money, which, in the face of decreased supply, increases demand beyond the available goods and services. Consequently, this excess demand leads to higher prices, hence contributing to inflation. Understanding this mechanism is crucial as it highlights the dynamics between supply, demand, and monetary policy in determining price levels within an economy.