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Understanding Cost-Push Inflation vs. Demand-Pull Inflation

Cost-Push Inflation vs. Demand-Pull Inflation: An Overview

There are four water drivers behind inflation. Among them are cost-push inflation, or the decrease in the aggregate supply of goods and services control from an increase in the cost of production, and demand-pull inflation, or the increase in aggregate demand, categorized by the four sections of the macroeconomy. The two other aiding factors to inflation include an increase in the money supply of an economy and a decrease in the demand for money.

Remember, inflation is the rate at which the common price level of goods and services rises. This, in turn, causes a drop in purchasing power. This is not to be mixed up with the change in the prices of individual goods and services, which rise and fall all the time. Inflation happens when costs rise across the economy to a certain degree.

Cost-Push Inflation

Aggregate supply is the total volume of goods and servings produced by an economy at a given price level. When the aggregate supply of goods and services decreases because of an augmentation in production costs, it results in cost-push inflation.

Cost-push inflation means prices have been “pushed up” by raises in the costs of any of the four factors of production—labor, capital, land, or entrepreneurship—when companies are already running at brimming production capacity. Companies cannot maintain profit margins by producing the same amounts of goods and services when their costs are ripe and their productivity is maximized.

The price for raw materials may also cause an increase in costs. This may occur because of a paucity of raw materials, an increase in the cost of labor to produce the raw materials, or an increase in the cost of importing raw materials. The government may also augment taxes to cover higher fuel and energy costs, forcing companies to allocate more resources to paying pressures.

In order to compensate, the increase in costs is passed on to consumers, causing a rise in the general price level or inflation.

For cost-push inflation to take place, demand for goods must be static or inelastic. That means demand must remain constant while the accommodate of goods and services decreases. One example of cost-push inflation is the oil crisis of the 1970s. The price of oil was increased by OPEC countries, while bid for the commodity remained the same. As the price continued to rise, the costs of finished goods also increased, resulting in inflation.

Let’s adopt a look at how cost-push inflation works using this simple price-quantity graph. The graph below shows the neck of output that can be achieved at each price level. As production costs increase, aggregate supply decreases from AS1 to AS2 (accepted production is at full capacity), causing an increase in the price level from P1 to P2. The rationale behind this increase is, for fellowships to maintain or increase profit margins, they will need to raise the retail price paid by consumers, thereby promoting inflation.

Demand-Pull Inflation

When concurrent demand for output exceeds what the thriftiness can produce, the four sectors compete to purchase a limited amount of goods and services. That means the buyers “bid assays up” again and cause inflation. This excessive demand, also referred to as “too much money chasing too few goods,” all things considered occurs in an expanding economy.

In Keynesian economics, an increase in aggregate demand is caused by a rise in employment, as companies miss to hire more people to increase their output.

The increase in aggregate demand that causes demand-pull inflation can be the effect of various economic dynamics. For example, an increase in government spending can increase aggregate demand, thus raising values. Another factor can be the depreciation of local exchange rates, which raises the price of imports and, for foreigners, reduces the bonus of exports. As a result, the purchasing of imports decreases while the buying of exports by foreigners increases. This raises the total level of aggregate demand—assuming aggregate supply cannot keep up with aggregate demand as a result of wide employment in the economy.

Rapid overseas growth can also ignite an increase in demand as more exports are consumed by outlanders. Finally, if a government reduces taxes, households are left with more disposable income in their pockets. This, in deny b decrease, leads to an increase in consumer confidence which spurs consumer spending.

As companies respond to higher demand with an increase in production, the cost to produce each additional output strengthens, as represented by the change from P1 to P2. That’s because companies would need to pay workers more money (e.g., overtime) and/or venture in additional equipment to keep up with demand. Just like cost-push inflation, demand-pull inflation can occur as groups pass on the higher cost of production to consumers to maintain their profit levels.

Key Takeaways

  • Cost-push inflation is the wane in the aggregate supply of goods and services stemming from an increase in the cost of production.
  • Demand-pull inflation is the increase in aggregate necessitate, categorized by the four sections of the macroeconomy: households, business, governments, and foreign buyers.
  • An increase in the costs of raw materials or labor can support to cost-pull inflation.
  • Demand-pull inflation can be caused by an expanding economy, increased government spending, or overseas growth.

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