Demand Pull and Cost Push Inflation, Reasons and Impact on Aggregate Demand and Supply

BUSINESS ECONOMICS
STUDENT ID:
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Question 3
(a) The diagram highlighting the demand pull inflation is exhibited below.
It is evident that the key cause leading to demand pull inflation is the increase in aggregate
demand which causes the AD curve to shift from the right. Meanwhile the AS curve does not
exhibit any change. The resultant equilibrium point indicates a higher price and higher real
output (Mankiw, 2014).
The diagram highlighting the cost push inflation is exhibited below.
There is rise of production costs and hence the AS decreases leading to shift on the left side
(AS1 to AS2). Meanwhile the AD curve does not exhibit any change. The resultant
equilibrium point indicates a higher price (P2) and lower real output (Y2) (Koutsoyiannis,
2013).
(b) Demand pull is attributed to the following reasons (Krugman and Wells, 2014).

(i) Money supply increase– When there is a money supply increase, then there would be a
drop in the interest rates and consequently higher borrowings leading to increased spending
by consumers.
(ii) Lower tax burden – Another reason which may lead to demand pull inflation is the
lowering tax rate which would enhance the disposable income for the consumers leading to
higher consumption related expenditure and aggregate demand.
Cost push is attributed to the following reasons (Koutsoyiannis, 2013).
(i) Raw material rising cost – The costs of production would increase owing to higher costs
associated with raw material procurement and this would lead to lower supply since some
inefficient producers may shut down.
(ii) Increase in labour cost – The costs of production may also increase on account of the hike
in wages or salaries of workers and employees which would lower the margins especially if
the higher price cannot be passed to consumers. As a result, there would be lower supply and
consequently higher price.
Question 5
(a) There would be an adverse impact on consumption as the marketing skills of the people
worsen which would lead to aggregate demand fall. The relevant graph indicating this is
illustrated as follows.