Demand-pull inflation is asserted to arise when
aggregate demand
In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is ...
in an economy is more than
aggregate supply
In economics, aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that fir ...
. It involves
inflation rising as real
gross domestic product rises and
unemployment falls, as the economy moves along the
Phillips curve. This is commonly described as "too much money chasing too few
goods". More accurately, it should be described as involving "too much money spent chasing too few goods", since only money that is spent on goods and services can cause inflation. This would not be expected to happen, unless the economy is already at a
full employment level. It is the opposite of
cost-push inflation.
How it happens
In
Keynesian theory
Keynesian economics ( ; sometimes Keynesianism, named after British economist John Maynard Keynes) are the various macroeconomic theories and models of how aggregate demand (total spending in the economy) strongly influences economic output an ...
, increased employment results in increased aggregate demand (AD), which leads to further hiring by firms to increase output. Due to capacity constraints, this increase in output will eventually become so small that the price of the good will rise.
At first, unemployment will go down, shifting AD1 to AD2, which increases demand (noted as "Y") by (Y2 − Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift.
This increase in price is what causes inflation in an overheating economy.
Demand-pull inflation is in contrast with
cost-push inflation, when price and wage increases are being transmitted from one sector to another.
However, these can be considered as different aspects of an overall inflationary process: demand-pull inflation explains how price inflation starts, and cost-push inflation demonstrates why inflation once begun is so difficult to stop.
Causes of demand-pull inflation
* There is a quick increase in consumption and investment along with extremely confident firms.
* There is a sudden increase in exports due to huge under-valuation of the currency.
* There is a lot of government spending.
* The expectation that inflation will rise often leads to a rise in inflation. Workers and firms will increase their prices to 'catch up' to inflation.
* There is excessive monetary growth, when there is too much money in the system chasing too few goods. The 'price' of a good will thus increase.
* There is a rise in population.
See also
*
Built-in inflation
Built-in inflation is a type of inflation that results from past events and persists in the present.
Built-in inflation is one of three major determinants of the current inflation rate. In Robert J. Gordon's triangle model of inflation, the curre ...
*
Cost-push inflation
*
Demand shock
In economics, a demand shock is a sudden event that increases or decreases demand for goods or services temporarily.
A positive demand shock increases aggregate demand (AD) and a negative demand shock decreases aggregate demand. Prices of goods a ...
*
Triangle model
A triangle is a polygon with three edges and three vertices. It is one of the basic shapes in geometry. A triangle with vertices ''A'', ''B'', and ''C'' is denoted \triangle ABC.
In Euclidean geometry, any three points, when non-collinear ...
*
Demand-pull theory
In economics, the demand-pull theory is the theory that inflation occurs when demand for goods and services exceeds existing supplies. According to the demand pull theory, there is a range of effects on innovative activity driven by changes in exp ...
Notes
External links
Theory 1 - Demand-pull inflation - is inflation demanding? Bank of Biz/ed
{{Economics
Demand
Inflation