Causes and Effects of Demand-Pull and Cost-Push Inflation

Running head: ASSIGNMENT 1
ASSIGNMENT
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ASSIGNMENT 2
Question3
a.
Demand-pull inflation occurs when an economy’s aggregate demand is more than the
aggregate supply (Godin & Lane, 2013). Therefore the economy experiences an imbalance in
aggregate demand and supply and hence the market equilibrium under the AD-AS model is
distorted. This type of inflation occurs as the economy grows on the other hand. This is because
as aggregate demand increases, total consumption in the economy increases as well and hence
more output is produced to meet the rising demand. The increase in demand at a faster pace as
compared to supply leads to much income in the form of money by consumers chasing only a
few commodities which do not satisfy consumers fully. As the aggregate demand increases, the
production level in the economy reaches its optimal point where no more goods and services can
be produced to satisfy consumer high demand. When the economy reaches this point, the
aggregate demand curve shifts towards the right direction from point AD0 to AD1 and this leads
to economic growth as the total output increases from Q0 to Q1 while the market prices from P0 to
P1 leading to demand-pull inflation in the economy as indicated in the diagram below.

ASSIGNMENT 3
Cost-push inflation in a nation’s economy occurs when the nation’s aggregate supply
decreases. It usually occurs when firms operating in the economy exceed their productivity
beyond the optimum production volume (Totonchi, 2011). Contrary to demand-pull inflation,
cost-push inflation is coupled with a decline in a nation’s economic growth. Production of firm’s
above the optimum production point increases the production costs for firms and hence their
productivity for any production above the optimal point leads to a decline in their profitability
(Beullens & Janssens, 2011). The decrease in the firms’ profits leads to a decrease in supply as
the firms reduce their supply towards a production and supply point which yields higher profits.
This leads to a shift in the nation’s aggregate supply curve towards the left direction from AS0 to
AS1 and this leads to a decline in economic growth as total output produced decreases from Q0 to
Q1 whilst the market prices increase from P0 to P1 leading to cost-push inflation as indicated in
the below diagram.

ASSIGNMENT 4
b.
Causes of Demand-Pull Inflation
Demand-pull inflation may result from an increase in consumer level of income. When
consumers have more income with them, then they tend to spend more. This is because of the
increase in demand for goods and services which results from increased consumer expenditure.
Due to high consumption, aggregate demand in the economy increases more than the aggregate
supply. As a result, the price for goods and services increases leading to demand-pull inflation.
Demand-pull inflation may also result from the expectations of consumers of prices in the
market to increase in the future. If consumers anticipate a rise in prices in the future, they
purchase more goods and services to avoid the future expected costs which may result from the