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Short-run Causes: Demand-Pull and Cost-Push Ä Ä Ä Ä Ä Ä 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. www.compasslearning.com 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