Demand-pull inflation occurs when
aggregate demand
In economics, 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 the ...
in an economy is more than
aggregate supply. It involves
inflation
In economics, inflation is an increase in the average price of goods and services in terms of money. This increase is measured using a price index, typically a consumer price index (CPI). When the general price level rises, each unit of curre ...
rising as
real gross domestic product
Real gross domestic product (real GDP) is a macroeconomic measure of the value of economic output adjusted for price changes (i.e. inflation or deflation). This adjustment transforms the money-value measure, nominal GDP, into an index for quantit ...
rises and
unemployment
Unemployment, according to the OECD (Organisation for Economic Co-operation and Development), is the proportion of people above a specified age (usually 15) not being in paid employment or self-employment but currently available for work du ...
falls, as the economy moves along the
Phillips curve. This is commonly described as "too much money chasing too few
goods
In economics, goods are anything that is good, usually in the sense that it provides welfare or utility to someone. Alan V. Deardorff, 2006. ''Terms Of Trade: Glossary of International Economics'', World Scientific. Online version: Deardorffs ...
". 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
Full employment is an economic situation in which there is no cyclical or deficient-demand unemployment. Full employment does not entail the disappearance of all unemployment, as other kinds of unemployment, namely structural and frictional, may ...
level. It is the opposite of
cost-push inflation.
How it occurs
In
Keynesian theory, 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
*
Cost-push inflation
*
Demand shock
*
Triangle model
*
Demand-pull theory
Notes
External links
Theory 1 - Demand-pull inflation - is inflation demanding?, Bank of Biz/ed
{{Economics
Demand
Inflation