Demand-pull and Cost-push Inflation

Running head: SEMISTER ASSIGNMENT 1
SEMISTER 1 ASSIGNMENT
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SEMISTER 1 ASSIGNMENT 2
Question3
a.
Demand-pull Inflation
An increase in the aggregate demand will cause demand-pull inflation. This means that
demand-pull inflation occurs in the economy when aggregate demand increases more than the
aggregate supply (Dmitrieva & Ushakov, 2011). This scenario occurs when too much money in
an economy chases few goods and services available which cannot meet consumer demand
sufficiently. As this inflation occurs, the economy grows on the other hand and hence
unemployment in the economy declines. This is because producers produce more goods and
services when demand increases in an attempt to meet the high consumer demand. The increase
in productivity involves the employment of more workers in order to participate in extra
productivity to meet the increased demand. However, producers reach an optimal point in their
production whereby they can’t produce more goods and services as more productivity becomes
less profitable. This means that they reduce their production to avoid losses arising from
increased production and hence aggregate demand exceeds aggregate supply. Suppliers,
therefore, increase prices for their goods and services as supply is outstripped by demand. This
rise in prices causes demand-pull inflation. The following diagram is used to explain this
scenario.

SEMISTER 1 ASSIGNMENT 3
From the diagram, it is evident that the increase in demand by consumers leads to an
increase in aggregate demand in an economy. This shifts the aggregate demand curve towards
the right direction from the initial point AD0 to AD1. This leads to an increase in total quantity in
the economy from Q0 to Q1. The resulting market prices increase from P0 to P1 causing demand-
pull inflation.
Cost-push Inflation
Cost-push inflation results from a decrease in aggregate supply in an economy (Amadeo,
2016). This usually occurs due to an increase in the costs of production for firms operating in an
economy. Production costs for firms may occur due to various factors such as the increase in cost
for factor inputs among others. This means that due to the rise in the cost of factor inputs such as
raw materials and labor, firms face increased production costs which reduce their profitability at
their current level of production. Firms, therefore, reduce their production to avoid losses
resulting from increased production and this reduces the aggregate supply in an economy. As a
result of the aggregate supply curve shifts towards the left direction from the initial point AS0 to

SEMISTER 1 ASSIGNMENT 4
AS1. This leads to a decline in a nation’s economic growth as the total output in the economy
reduces from the initial point Q0 to Q1. The corresponding prevailing market prices increase from
P0 to P1 and this price increment leads to cost-push inflation as indicated in the below graph.
b.
Demand-pull Inflation Causes
The future expectation of inflation causes demand-pull inflation (Gaspar, Smets &
Vestin, 2010). If consumers expect a rise in prices in the future, they purchase more goods and
services to avoid future increased costs which may result from the increased future prices. This
increases demand in the economy and hence aggregate demand increases as a faster pace as
compared to the aggregate supply. This makes suppliers to increase their prices as aggregate
supply is outstripped by the aggregate demand and this leads to demand-pull inflation.