1

Demand Pull Inflation

Demand Pull Inflation occurs when Aggregate demand (C+I+G+(X-M)) increases at a rate faster than the capacity of the economy to produce goods and services ie: AD>AS. This increase competition for goods and services drives up their prices.

2

Demand Pull Inflation

P2

P1

Q2Q1

Aggregate Supply

Aggregate Demand 2

Aggregate Demand 1

Price $

Real GDP ($)

3

Demand Pull Inflation

An increase in demand shifts the aggregate demand curve to the right, from AD1 to AD2 pushing up the price level from P1 to P2.

4

Sources ofDemand Pull Inflation

Any increase in Aggregate Demand (C + I + G + ( X – M ) ) as the economy approaches full employment.

5

Sources ofDemand Pull Inflation

Full employment causes labour shortages, employers thus bid up wages to attract labour. The increased income, transpires into increased consumption causing Aggregate Demand to rise.

6

Sources ofDemand Pull Inflation

High levels of foreign investment increases employment, income, consumptions and ultimately Aggregate Demand.

7

Sources ofDemand Pull Inflation

Growth in foreign economies can lead to higher incomes for our exporters, thus allowing increases in Aggregate Demand.

8

Sources ofDemand Pull Inflation

Inflationary expectations – If members of an economy expect prices to rise, it brings forward expenditure decisions leading to demand pull inflation eg: Pre GST in Australia.

9

Sources ofDemand Pull Inflation

Increasing consumption due to changes in consumption patterns (less savings at any level of income).

10

Sources ofDemand Pull Inflation

Monetary consideration – too much credit in the economy. A relaxed monetary policy leads to a reduction in interest rates leading to an increase in Aggregate Demand and thus prices.

11

Cost Push Inflation

Cost Push Inflation occurs when prices are pushed up by rising costs to producers who compete with each other for increasingly scarce resources. The increased costs are passed onto consumers.

12

Cost Push Inflation

P2

P1

Q2 Q1

Aggregate Supply 2

Aggregate Demand

Price $

Real GDP ($)

Aggregate Supply 1

13

Cost Push Inflation

An increase in the prices of inputs shifts the aggregate Supply Curve to the left, from AS1 to AS2 pushing up the price level from P1 to P2.

14

Sources of Cost Push Inflation

Any input may become a major cost to business eg: wage increases lead to higher production costs.

15

Sources of Cost Push Inflation

Labour shortages in some sectors necessitate wage increases in that sector, however it has a domino effect leading to wage rises in other sectors.

16

Sources of Cost Push Inflation

NB: Wage rises in excess of productivity increase leads to inflationary pressure.

The extend to which a producer can pass on price rises depends on the level of competition in the industry.

The more competitive the industry, the more the producer has to absorb costs rather than pass them onto consumers.

17

Sources of Cost Push Inflation

Inflation imported from abroad, eg: the rise in the cost of intermediate goods and resources imported from other countries flows through in the form of higher prices domestically eg: oil prices.

18

Sources of Cost Push Inflation

Government budgetary problems – an increase in the cost of public utilities eg: electricity, water etc, leads to higher costs to business and households.