Question

Relationship between demand-pull inflation and cost-push inflation

Answer 1

Answer:

KEY TAKEAWAYS

Cost-push inflation is the decrease in the aggregate supply of goods and services stemming from an increase in the cost of production.

Demand-pull inflation is the increase in aggregate demand, categorized by the four sections of the macroeconomy: households, business, governments, and foreign buyers.  

An increase in the costs of raw materials or labor can contribute to cost-pull inflation.

Demand-pull inflation can be caused by an expanding economy, increased government spending, or overseas growth.

Cost-Push Inflation

Aggregate supply is the total volume of goods and services produced by an economy at a given price level. When the aggregate supply of goods and services decreases because of an increase in production costs, it results in cost-push inflation.

Cost-push inflation means prices have been "pushed up" by increases in the costs of any of the four factors of production—labor, capital, land, or entrepreneurship—when companies are already running at full production capacity. Companies cannot maintain profit margins by producing the same amounts of goods and services when their costs are higher and their productivity is maximized.

The price of raw materials may also cause an increase in costs. This may occur because of a scarcity of raw materials, an increase in the cost of labor to produce the raw materials, or an increase in the cost of importing raw materials. The government may also increase taxes to cover higher fuel and energy costs, forcing companies to allocate more resources to paying taxes.

In order to compensate, the increase in costs is passed on to consumers, causing a rise in the general price level: inflation.

For cost-push inflation to occur, demand for goods must be static or inelastic. That means demand must remain constant while the supply of goods and services decreases. One example of cost-push inflation is the oil crisis of the 1970s. The price of oil was increased by OPEC countries, while demand for the commodity remained the same. As the price continued to rise, the costs of finished goods also increased, resulting in inflation.

Explanation: