Cost-Push Inflation vs Demand-Pull Inflation

Definition of Cost-Push Inflation

Inflation can result from a decrease in aggregate supply. The two main sources of decrease in aggregate supply are

• An increase in wage rates
• An increase in the prices of raw materials

These sources of a decrease in aggregate supply operate by increasing costs, and the resulting inflation is called cost-push inflation

Other things remaining the same, the higher the cost of production, the smaller is the amount produced. At a given price level, rising wage rates or rising prices of raw materials such as oil lead firms to decrease the quantity of labor employed and to cut production.

Definition of Demand-Pull Inflation

The inflation resulting from an increase in aggregate demand is called demand-pull inflation. Such an inflation may arise from any individual factor that increases aggregate demand, but the main ones that generate ongoing increases in aggregate demand are

1. Increases in the money supply
2. Increases in government purchases
3. Increases in the price level in the rest of the world.

The three most likely causes of an increase in aggregate demand will also tend to increase inflation:

1. Increases in the money supply This is simply factor 1 inflation.

2. Increases in government purchases The increased demand for goods by the government causes factor 4 inflation.

3. Increases in the price level in the rest of the world Suppose you are living in the United States. If the price of gum rises in Canada, we should expect to see less Americans buy gum from Canadians and more Canadians purchase the cheaper gum from American sources. From the American perspective the demand for gum has risen causing a price rise in gum; a factor 4 inflation.