Download Short-run Causes: Demand-pull and Cost-push

Short-run Causes: Demand-Pull and Cost-Push
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Demand-pull inflation occurs when increasing demand causes real GDP
and prices to increase.
Under conditions of demand-pull inflation, increased employment and
higher wages increase production costs.
Demand-pull inflation is often associated with an expanding economy, or an
economic boom.
Cost-push inflation is caused by a supply shock with a result of
increasing prices correlated with decreasing GDP. A supply shock is a
sudden increase in the price of resource inputs.
Under conditions of cost-push inflation, increased input prices increase
production costs.
Cost-push inflation is often associated with economic stagflation.
When consumers, business, the
government, and/or foreigners decide
to increase their spending, aggregate
demand increases. As production
increases, firms hire more workers and
begin to compete for labor with higher
wages. When production costs rise,
firms pass the higher costs on to
buyers as higher prices and inflation
begins to rise.
Often workers will bargain for even
higher wages as prices and the cost of
living begin to increase. Contractual
agreements, such as Social Security
payments and cost-of-living
adjustments, automatically increase
wages. Also, in an inflationary
economy, people tend to spend today,
and this spending also perpetuates
demand-pull.
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Copyright ã 2006, Thinkwell Corp. All Rights Reserved.
1204.doc –rev 11/07/2006
Inflation can also result from the
supply side of the economy. A supply
shock will increase the price of inputs
for producers, who then raise the
prices of their products. Because
resource inputs are more expensive,
production slows and employment
decreases. Consumption also slows
because of higher prices. The result is
stagflation, characterized by an
increasing inflation rate and decreasing
or stagnant output.
www.compasslearning.com
Copyright ã 2006, Thinkwell Corp. All Rights Reserved.
1204.doc –rev 11/07/2006