This article will help you to learn about the difference between demand-pull and cost-push inflation.
Difference between Demand-Pull and Cost-Push Inflation
In the demand-pull inflation case, it is an excess demand in the product markets that pulls or bids prices upward. Increased profitability of production in turn creates an excess demand in the labour market which pulls wage rates up.
In short, in demand inflation, excess product demand pulls up goods prices, creating excess labour demand which pulls up wages. In the cost-push inflation case, the causal sequence is reversed. Wage rates then rise without excess demand, which creates an actual or potential shortage of goods at the old price level. The shortage bids up prices.
Cost-push inflation can be the result of bargaining power by resource owners, poor productivity, limited availability of resources, or chance events. For example, members of a large profession demanding and obtaining higher incomes, political unrest overseas that disrupts the supply of a resource critical to producers in India, or chance events like the weather problems that affected grain yields could all contribute to inflationary pressure.
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Cost-push inflation will more likely result when cost increases push up the product prices of large firms that play important roles in the economy, such as automobile producers, or push up the product prices of a significant number of firms. For example, increases in the cost of energy and health care nave an impact on almost every seller, large or small, in the economy.
Inflation need not come solely from the buyers’ side or solely from the sellers’ side of the market; it can come simultaneously from both sides. For example, suppose that an increase in overall demand caused by more government spending leads to demand-pull inflation. As a result, individuals facing higher prices negotiate higher incomes from their employers.
Employers — who are now incurring higher costs because of wage demands — pass those costs on to their buyers in the form of higher prices, which, in turn, contributes to cost-push inflationary pressure. It is easy to see from this example how inflation could spiral: Rising prices form strong demand could cause resource owners to seek higher incomes, which, in turn, could cause businesses to raise their prices to pay the higher incomes.
The Role of Expectations:
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The influence of expectations of future economic conditions on both demand-pull and cost-push inflation is important. On the demand-pull side, buyers’ fears of higher prices in the future may lead them to increase their current purchases before the expected higher prices become reality.
At full employment, this increased demand will put additional pressure on an economy already operating at its productive capacity and will result in a rise in prices. On the sellers’ side, firms that expect increasing costs might raise prices in anticipation of those higher costs. Thus, a curious situation results in which the expectation of rising prices could trigger inflation.