key term - Demand-Pull Inflation

Definition

Demand-pull inflation is a type of inflation that occurs when the total demand for goods and services in an economy exceeds the total supply, causing prices to rise. This imbalance between demand and supply leads to a self-reinforcing cycle of increasing prices as consumers compete for limited resources.

5 Must Know Facts For Your Next Test

1. Demand-pull inflation is a key concept in the Aggregate Demand-Aggregate Supply (AD-AS) model, which is used to analyze the relationship between economic growth, unemployment, and inflation.
2. Factors that can lead to demand-pull inflation include increased consumer spending, investment, government spending, and net exports, which all contribute to a rise in aggregate demand.
3. Demand-pull inflation is often associated with periods of economic growth and full employment, as high demand outstrips the economy's ability to supply goods and services.
4. The Phillips Curve, which shows the inverse relationship between unemployment and inflation, is also relevant to understanding demand-pull inflation and its impact on the economy.
5. Demand-pull inflation is a common phenomenon in developing and emerging economies, where rapid economic growth and increasing consumer demand can outpace the expansion of productive capacity.

Review Questions

• Explain how the Aggregate Demand-Aggregate Supply (AD-AS) model is used to analyze demand-pull inflation.
  • The AD-AS model is a key tool for understanding demand-pull inflation. In this model, demand-pull inflation occurs when aggregate demand (AD) increases, shifting the AD curve to the right. This causes the equilibrium price level to rise, as the economy cannot fully meet the increased demand with the existing level of aggregate supply (AS). The resulting gap between AD and AS leads to upward pressure on prices, resulting in demand-pull inflation.
• Describe the relationship between demand-pull inflation and the Phillips Curve.
  • The Phillips Curve, which depicts the inverse relationship between unemployment and inflation, is closely linked to demand-pull inflation. During periods of high aggregate demand and economic growth, low unemployment can lead to increased consumer spending and wage pressures, resulting in demand-pull inflation. Conversely, when aggregate demand is weak and unemployment is high, the Phillips Curve suggests that inflation will be low, as firms have less pricing power and workers have less bargaining power.
• Analyze the factors that contribute to demand-pull inflation in developing and emerging economies.
  • Demand-pull inflation is a common challenge in developing and emerging economies, where rapid economic growth and increasing consumer demand often outpace the expansion of productive capacity. Factors that can contribute to demand-pull inflation in these contexts include: 1) Rapid urbanization and the growth of a middle class with higher incomes and spending power, 2) Large inflows of foreign investment and capital, which can fuel asset price bubbles and consumer spending, 3) Underdeveloped supply chains and infrastructure that struggle to keep up with rising demand, and 4) Dependence on imports of essential goods, which can be vulnerable to exchange rate fluctuations and supply shocks.

Related terms

Aggregate Demand:

The total demand for all goods and services in an economy at a given price level and time period.

Aggregate Supply:

The total quantity of goods and services that firms are willing to sell at different price levels in a given time period.

Inflation:

A sustained increase in the general price level of goods and services in an economy over time.