Demand-Pull and Cost-Push Inflation (2024)

FAQs

Demand-Pull and Cost-Push Inflation? ›

Cost-push inflation is the decrease in the aggregate supply of goods and services, often stemming from an increase in the cost of production. Demand-pull inflation is inflation caused by an increase in aggregate demand. An increase in the costs of raw materials or labor can contribute to cost-pull inflation.

Demand-pull inflation includes times when an increase in demand is so great that production can't keep up, which typically results in higher prices. In short, cost-push inflation is driven by supply costs while demand-pull inflation is driven by consumer demand—while both lead to higher prices passed onto consumers.

Demand-pull inflation is generally regarded as less of a macroeconomic problem than cost-push inflation, as it also results in more output. In fact, policymakers often prefer a steady, low rate of inflation to no inflation. Cost-push inflation is a more serious problem, since it is usually combined with less output.

Stagnation is a combined phenomena of demand pull and cost push inflation as general price level starts rising due to some mismatch between the demand and supply of the commodities as a result of which factor cost rises persistently which results in inflation.

Inflation measures how quickly the prices of goods and services are rising. Inflation is sometimes classified into three types: demand-pull inflation, cost-push inflation, and built-in inflation. The most commonly used inflation indexes are the Consumer Price Index and the Wholesale Price Index.

For example, a central bank might increase interest rates to counter demand-pull inflation, leading consumers to spend less on housing and products. This in turn lowers demand, allowing producers to catch up with supply and restoring balance. Governments can also reduce government spending or raise taxes.

Cost-push inflation is essentially when an increase in production costs are passed on to customers who are buying those final goods. A company that produces computers, for example, will have a hard time selling their products to the same number of customers at the same price if the cost of production rises.

Doepke and Schneider (2006) studied the scale of this redistribution and found that the main losers from inflation are old, rich households—the major bondholders in the economy.

Inflation is measured by the consumer price index (CPI), and at low rates, it keeps the economy healthy. But when the rate of inflation rises rapidly, it can result in lower purchasing power, higher interest rates, slower economic growth and other negative economic effects.

Monetary policy primarily involves changing interest rates to control inflation. Fiscal policy enacted through legislative action also helps. Governments may reduce spending and increase taxes as a way to help reduce inflation.

Can you have inflation and recession at the same time? ›

In economics, stagflation (or recession-inflation) is a situation in which the inflation rate is high or increasing, the economic growth rate slows, and unemployment remains steadily high.

The demand-pull theory of inflation suggests that the cost of goods and services rises when demand is greater than the available supply. This model of supply/demand imbalance reflects one of the most common definitions of inflation: “Too much money chasing too few goods.”

This increased demand is “pulling” up prices. Employment is rising also which means consumers have more disposable income. Gasoline demand and prices are rising as more employees drive to work. Airline tickets and hotel rooms are also rising as pent-up consumers increase travel.

Demand-pull inflation is driven by consumers, while cost-push inflation is driven by producers.

Disadvantages. It increases the prices of the things people buy, reducing their purchasing power. It distorts the value of money, making it hard to interpret changing prices and wages. It increases borrowing costs, since banks now will demand a higher interest rate to make up for the value of money lost to inflation.

Government spending: Government spending increases demand for certain products. Government policies like tax decreases also have an impact, because they give consumers a higher discretionary income for spending on goods and services. If this outpaces supply, it causes demand-pull inflation.