Demand Pull Inflation arises when the aggregate demand goes up rapidly than the aggregate supply in an economy. Out of these six factors, the first four factors, will result in the rise in the level of disposable income. The increase in aggregate income result in the increase in aggregate demand for goods and services, causing demand-pull inflation. Cost push inflation means the increase in the general price level caused by the rise in prices of the factors of production, due to the shortage of inputs i.
It results in the decrease in the supply of outputs which mainly use these inputs. So, the rise in prices of the goods emerges from the supply side. Moreover, cost-push inflation may also be caused by depletion of natural resources, monopoly and so on. There are three kinds of cost-push inflation:. The differences between dDemand-pull and cost-push inflation can be drawn clearly on the following grounds:. Therefore, you can conclude with the above discussion the main reason for causing inflation in the economy is either by demand-pull or cost-push factors.
This excessive demand, also referred to as "too much money chasing too few goods," usually occurs in an expanding economy. In Keynesian economics, an increase in aggregate demand is caused by a rise in employment, as companies need to hire more people to increase their output.
The increase in aggregate demand that causes demand-pull inflation can be the result of various economic dynamics. For example, an increase in government spending can increase aggregate demand, thus raising prices. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases.
This raises the overall level of aggregate demand, assuming aggregate supply cannot keep up with aggregate demand as a result of full employment in the economy. Rapid overseas growth can also ignite an increase in demand as more exports are consumed by foreigners. Finally, if a government reduces taxes, households are left with more disposable income in their pockets.
This, in turn, leads to an increase in consumer confidence that spurs consumer spending. Looking again at the price-quantity graph, we can see the relationship between aggregate supply and demand. If aggregate demand increases from AD1 to AD2, in the short run , this will not change aggregate supply. Instead, it will cause a change in the quantity supplied, represented by a movement along the AS curve.
The rationale behind this lack of shift in aggregate supply is that aggregate demand tends to react faster to changes in economic conditions than aggregate supply. As companies respond to higher demand with an increase in production, the cost to produce each additional output increases, as represented by the change from P1 to P2. That's because companies would need to pay workers more money e.
Just like cost-push inflation, demand-pull inflation can occur as companies pass on the higher cost of production to consumers to maintain their profit levels. There are ways to counter both cost-push inflation and demand-pull inflation, which is through the implementation of different policies.
To counter cost-push inflation, supply-side policies need to be enacted with the goal of increasing aggregate supply. To increase aggregate supply, taxes can be decreased and central banks can implement contractionary monetary policies , achieved by increasing interest rates. Countering demand-pull inflation would be achieved by the government and central bank implementing contractionary monetary and fiscal policies. This would include increasing the interest rate; the same as countering cost-push inflation because it results in a decrease in demand, decreasing government spending, and increasing taxes, all measures that would reduce demand.
International Monetary Fund. Google Books. Patrick J. Welch and Gerry F. Accessed Jan. Your Privacy Rights. Back in the old times, people used silver coins in the exchange of goods. The government then collected all the silver coins and melted them, and also mixed other metals such as copper or lead to produce more coins at the same nominal value initial value. By diluting the silver, the government produced more coins without increasing any amount of silver.
This approach allowed the government to make profits because now the cost to make each coin is lowered while the value remains the same. This practice increases the money supply while simultaneously reducing the value of each coin, which results in consumers being required to give more coins in exchange for the same goods and services as before. In the present scenario, we can replace older coins with the new currency in order to get an idea of why the government cannot merely print more money to solve the problem of inflation.
As the name implies, it is a percentage of increase and decreases in the prices of goods and services during a certain period, generally a month or a year. The inflation rate is an important factor for the misery index , which is a combination of the unemployment rate and inflation. Another relevant blog: What is Financial Analysis?
There are many schools of thoughts regarding the cause of inflation. The cause can generally be divided into two broad categories: 1 Demand-pull inflation 2 Cost-push inflation. It is caused due to aggregate demand increasing faster than aggregate supply.
Imagine a scenario where there is suddenly increased demand for electric cars owing to the environmental policy imposed by the Government, so now due to the limited supply of electric vehicles, all the sellers will increase their prices which would result in demand-pull inflation. What is Cost Push Inflation 4. Demand pull inflation is asserted to rise when the level of aggregate demand in an economy outpaces aggregate supply levels.
Price is decided based on demand and supply. When the purchasing power of the consumers rises due to an increase in employment levels, this leads to a rise in demand. Suppliers see this as a favorable situation to obtain more profits; thus, they will maintain the supply at current levels in the short term and increase the volume of production gradually.
This was developed by the British economist John Maynard Keynes who stated that optimum economic performance could be achieved by influencing aggregate demand through activist stabilization economic intervention policies by the government. Rise in oil prices is a sound example of demand pull inflation; where the rise in prices is backed by ever-increasing demand.
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