Demand-pull inflation comes from total demand growing faster than output; cost-push comes from rising costs of production.
Demand-pull inflation happens when total demand rises faster than the economy can increase output. Too much money chases too few goods. Firms cannot keep up with orders, so they raise prices.
Causes of higher demand include rising consumer confidence, lower interest rates, tax cuts, more government spending, and strong demand for exports. The pressure is greatest when the economy is near full employment, because there are few idle workers or machines.
Cost-push inflation happens when firms' costs of production rise and they pass them on as higher prices. Causes include higher wages, dearer imported raw materials such as oil, and higher indirect taxes. A fall in the exchange rate also makes imports dearer.
The two can feed each other. When prices rise, workers ask for higher wages. Higher wages raise costs, and firms raise prices again. This is a wage-price spiral.
- Demand-pull
- Total demand grows faster than output.
- Cost-push
- Rising costs (wages, imported materials, taxes) passed on in prices.
- Wage-price spiral
- Higher prices lead to higher wages, which lead to higher prices.
Worked example: Spotting the cause
Identify the type of inflation in each case.
- Global oil prices double, raising transport and electricity costs: cost-push.
- Tax cuts and cheap loans lead to a spending boom near full employment: demand-pull.
- The currency falls sharply, so imported food and parts cost more: cost-push.
- Workers win large pay rises after prices rise, and firms raise prices again: a wage-price spiral.
Watch out for this
Inflation is caused by greedy firms deciding to raise prices.
Firms raise prices when demand outstrips supply or when their costs rise. Economists explain inflation through these demand and cost pressures.
Check your understanding
A sharp rise in the world price of oil pushes up prices across the economy. Which type of inflation is this?
- Cost-push
- Demand-pull
- Deflation