Causes and Effects of Demand-pull and Cost-push Inflation

Running head: SEMISTER ASSIGNMENT 1
SEMISTER 1 ASSIGNMENT B
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SEMISTER ASSIGNMENT 2
Question3
a.
Demand-pull Inflation
Demand-pull inflation usually results in an economy when the economy’s aggregate
demand outpaces the aggregate supply (Totonchi, 2011). A few goods available in the economy
which can’t adequately satisfy consumer wants are chased by a lot of money held by consumers.
As this type of inflation occurs, the economy actually grows. As the consumer demand increases
in the economy, businesses increase their productivity and hence hire more workers to produce
extra goods and services. The total output in the economy increases as the unemployment rate
decreases. However, producers eventually reach their maximum production point where further
production leads to decreased profits. At this point, the economy is said to at its peak and full
employment is attained. Businesses therefore avid further production and as a result the
aggregate demand outpaces the aggregate supply and this leads to an increase in the market
prices in the economy causing demand-pull inflation as indicated in the below graph.

SEMISTER ASSIGNMENT 3
As illustrated in the graph, an increase in consumer demand increases the aggregate
demand in the economy. As a result, the aggregate demand curve shifts to the right direction
from AD to AD’. The real gross domestic product in the economy increases from Y1 to Y2
indicating a growth of the economy. The prices in the economy increase from P1 to P2 leading to
demand-pull inflation as illustrated.
Cost-push Inflation
An economy experiences cost-push inflation when there is a decrease in its aggregate
supply (Smaghi, 2009). Aggregate supply decreases due to an increase in firms’ production
costs. The rise in production costs may result from the increase in costs for factors of production
such as wages and rent and various government regulations such as the increased taxes such as
corporate tax and VAT among others. The increased production costs reduce the firms’
profitability at their production level. They, therefore, minimize productivity to avoid further
decline in profitability and this reduces the economy’s aggregate supply. An occurrence of this
type of inflation makes the nation’s economic growth to decline. The real gross domestic product
decreases as unemployment increases since a decrease in aggregate supply decreases the quantity
produced and some workers are fired. An illustration is as follows.

SEMISTER ASSIGNMENT 4
As illustrated in the above diagram, an economy’s aggregate supply decrease shifts the
aggregate supply curve to the left direction from AS to AS’. The nation’s economic productivity
declines as the real gross domestic product decrease from Y1 to Y2. The market prices in the
economy increase from P1 to P2 causing cost-push inflation.
b.
Causes of Demand-pull Inflation
Future inflation expectation causes demand-pull inflation (Godin & Lane, 2013). If
consumers expect inflation in future, they increase their consumption by purchasing more goods
and services to avoid future higher prices. This increases aggregate demand more than the
aggregate supply and hence causes demand-pull inflation.
The over-expansion of a nation’s monetary policy causes demand-pull inflation (Singla,
Ahuja & Sethi, 2017). This occurs as more money is availed in the economy by the government
printing more money through the central bank. Consumers hold more money and as a result,
increase their expenditure. This increases aggregate demand more than the aggregate supply and
hence causes demand-pull inflation.
Causes of Cost-push Inflation
Cost-push inflation occurs when firms raise their profit margin (Weale et al, 2015). In
order for firms to attain the raised profit margin, they increase their prices and also lower their
supply. This means that the aggregate supply is decreased and consumers suffer by paying the
higher prices tailored towards achieving the desired profit by firms. This causes cost-push
inflation as firms categorize it under production costs.