Key Difference – Demand Pull Inflation vs Cost Push Inflation
The key difference between demand pull inflation and cost push inflation is that while demand pull inflation occurs when the demand in an economy rises to outpace the supply, cost push inflation takes place when the cost of production increases in terms of the rise in prices of raw materials, labor and other inputs. Inflation is the general increase in price levels in the economy where demand pull and cost push are the two main causes of inflation.
CONTENTS
1. Overview and Key Difference
2. What is Demand Pull Inflation
3. What is Cost Push Inflation
4. Side by Side Comparison – Demand Pull Inflation and Cost Push Inflation
5. Summary
What is Demand Pull Inflation?
Demand pull inflation is asserted to rise when the level of aggregate demand in an economy outpaces aggregate supply levels. Price is decided based on demand and supply. When the purchasing power of the consumers rises due to an increase in employment levels, this leads to a rise in demand. Suppliers see this as a favorable situation to obtain more profits; thus, they will maintain the supply at current levels in the short term and increase the volume of production gradually.
The concept of demand pull inflation was first introduced in an economic theory named ‘Keynesian economics’. This was developed by the British economist John Maynard Keynes who stated that optimum economic performance could be achieved by influencing aggregate demand through activist stabilization economic intervention policies by the government.
E.g. Rise in oil prices is a sound example of demand pull inflation; where the rise in prices is backed by ever-increasing demand.
What is Cost Push Inflation?
Cost push inflation is the inflation caused by an increase in prices of inputs (factors of production) such as raw materials, labor and other inputs. The increased price of the factors of production leads to a decreased supply of these goods. There are a number of reasons for the possible rise in input costs which may be anticipated or unexpected.
Reasons for Increase in Input Costs
- Limited availability of raw materials due to destruction of natural resources and natural disasters
- Establishment or increase in minimum wage
- Government regulation
- If raw materials are imported, then the effects of exchange rate should be considered as well. (If a country’s currency appreciates, then import cost is cheaper)
Cost push inflation happens when demand remains constant during the time the production cost changes are occurring. To compensate for the increased cost of production, the suppliers upsurge the prices to maintain profits while keeping pace with expected demand.
What is the difference between Demand Pull Inflation and Cost Push Inflation?
Demand Pull Inflation vs Cost Push Inflation |
|
| Demand pull inflation occurs when the demand in an economy rises to outpace the supply. | Cost push inflation takes place when the cost of production increases in terms of rise in prices of raw materials, labor and other inputs. |
| Nature | |
| Demand pull inflation can be explained through Keynesian theory. | Cost push inflation is a ‘supply-side’ theory. |
| Occurrence | |
| Shift in consumer preferences results in demand pull inflation | Availability of factors of production and government policy results in cost push inflation. |
Summary – Demand Pull Inflation vs Cost Push Inflation
The difference between demand pull inflation and cost push inflation is attributed to demand and supply as explained above. Demand pull inflation and cost push inflation occurs when either the demand or supply cannot adjust in relation to the other. For instance, cost push inflation occurs when demand cannot be easily adjusted to rising price levels. Inflation is a macroeconomic factor, i.e., it affects all individuals, companies, and industries and is not restricted to selected parties. Thus, an increase in a single type of raw material or product cannot be explained through inflation; it is measured for the economy as a whole.
References
Clemente, Jude. “Global Oil Demand Can Only Increase.” Forbes. Forbes Magazine, 29 Aug. 2016. Web. 16 Mar. 2017.
“Demand-Pull Inflation.” Investopedia. N.p., 14 Aug. 2015. Web. 16 Mar. 2017.
“Definition of ‘Cost Push Inflation'” The Economic Times. N.p., n.d. Web. 16 Mar. 2017.
“Cost-Push Inflation.” Investopedia. N.p., 04 Sept. 2015. Web. 17 Mar. 2017.
Image Courtesy:
“As AD cost push” By Bkwillwm – Own work (GFDL) via Commons Wikimedia
Leave a Reply