Demand-Pull Inflation vs Cost-Push Inflation

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  • 0:01 Setting the Inflation Stage
  • 1:25 Demand-Pull Inflation
  • 3:49 Cost-Push Inflation
  • 5:07 Lesson Summary
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Lesson Transcript
Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Discover two basic types of inflation, demand-pull and cost-push inflation. Learn what factors cause each type of inflation and some of the key differences between each.

Setting the Inflation Stage

Why does the cost of milk and eggs keeping going up year after year? Why does the same model vehicle you purchased last year now cost $400 more? If you really want the accurate answer to those questions, you must first gain an understanding of demand-pull inflation and cost-push inflation.

First, let's recap what inflation is to help clarify our understanding of this topic. Inflation is the rate at which general prices of goods and services rises. As inflation rises, the dollar you have in your pocket won't buy the same amount of goods and services as it did before. For example, if inflation is 3%, the pack of chips that cost you $3 will cost you $3.09 next year.

Inflation can result and increase because of the following four main factors:

  1. Increase in the money supply
  2. The supply of goods going down
  3. Demand for money going down
  4. Demand for goods and services going up

Cost-push inflation is most closely tied to number two, the supply of goods going down. Demand-pull inflation is most closely a result of number four, the demand for goods and services going up. Let's explore each of these types of inflation in more detail.

Demand-Pull Inflation

Demand-pull inflation is a term used to describe when prices rise because the aggregate demand in an economy is greater than the aggregate supply. This imbalance essentially results in too much money chasing too few goods and services. For example, when many individuals are trying to purchase a new gaming system or a new smartphone that is limited in quantity, the price will usually rise. When this happens across the entire economy for many different goods and services, demand-pull inflation can result. The factors that can often cause this demand driven inflation are the following:

  • Increases in the money supply - This is one of the main focuses of the Federal Reserve. If an economy has too much money among its citizens, they will demand more product than firms can keep up with, pulling up prices.
  • Increases in government spending - When the government spends large amounts of money in the private sector through purchases and contracts, this increases demand for products and creates supply issues, ultimately pulling up prices.
  • Foreign growth or foreign price increases - If prices are rising in other countries, foreign consumers may demand the domestic products you buy at cheaper rates. This increase in demand can result in higher prices paid by you. If other countries experience large population growth, this can result in foreign citizens demanding more products from other countries and pulling up prices, too.

Demand-pull inflation often results at higher levels of employment or when employment is increasing in an economy. As more people have jobs, the aggregate demand in an economy increases. More people with money equals more goods and services wanted. Firms will try and hire more people to keep up with demand. As more people are hired and earn money, demand continues to increase for even more goods, and the cycle continues. Each time aggregate demand (AD) increases and shifts to the right (AD1 to AD2 to AD3), prices rise and inflation results.

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