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Lesson 20: Causes of Demand Pull & Cost Push Inflation

Module 1: Macro Fundamental Analysis

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Video Transcript

so in this lesson we’re going to look at demand pull inflation and demand pull inflation happens when the aggregate demand curve shifts to the right and you can see here we have our aggregate demand curves again and we have our short run aggregate supply curve and if we look at this as the intersection between the aggregate demand curve number one so our starting place and the short run aggregate supply you can see we have an equilibrium roughly of around

550 roughly in terms of real gdp output and if we move this to the left you can see we have roughly 55 as an equilibrium price point the average level of goods and services within the economy when the aggregate demand curve shifts to the right you can see we have a new equilibrium point over here and with this comes an increase in output as we looked at previously from roughly 550 to about 750 or 725 maybe and you can see the average level of goods and services within the economy actually increases we go from an average level of prices of goods and services of about 55 to about 70. this increase in the average level of prices of goods and services within the economy is demand pull inflation and when the aggregate demand curve shifts to the right we have inflation and we also have an increase in real gdp now what are the causes of demand pull inflation so what are the causes of a shift to the right in aggregate demand well we’ve been through this in previous videos we have consumption so an increase in consumption so it’s the c plus i plus g plus nx aggregates demand formula down here consumption increases we have a shift to the right in aggregate demand so that would be caused by consumer confidence increasing interest rates decreasing would cause consumption to rise as people would go out and borrow more and spend and a decrease in income tax because people would have more income more disposable income after taxes which would lead to high levels of consumption we have an increase in investment which would cause a shift to the right in aggregate demand so if we have an increase in business confidence this will cause an increase in investment if we have a decrease in interest rates this will also stimulate investments as companies will go out and borrow and spend and use loans in order to invest because they can maybe get loans very very cheap now and they don’t have much repayments to make and we could have a decrease in corporation taxes this would actually help companies retain more profits which they could then go and spend so this would also increase investment in the economy with a cut in corporation taxes we could just have an increase in government spending so we looked at this in more detail previously maybe infrastructure projects or we could have an increase in net exports we could have a devaluation of the currency on the exchange rate system and weaker currencies will mean more competitive exports so net exports will increase all of these factors cause demand pull inflation and shift the aggregate demand curve to the right now we’re going to look at the tab cost push inflation so why does cost push inflation occur within an economy and what causes cost push inflation well cost push inflation occurs when the short run aggregate supply curve shifts to the left and you can see if we start out with sras 1 on our aggregate demand curve we start here and this is our first equilibrium point and a shift to the left causes a new equilibrium point here because as prices rise demand decreases and it shifts along the ad curve left purely because of a change in prices and so we go from an original output of around 600 and an average level of prices of goods and services within the economy of around 60 to a new output level

of about 450 and a new average level of goods and services within the economy of about 75. so you can see this shifting to the left of the short run aggregate supply curve causes an increase in the average level of goods and services within the economy this is inflation this increase from around 60 to 75 here is indicative of cost push inflation and as you can see when cost push inflation occurs because of a shift to the left in short run aggregate supply this also causes a contraction in gdp and this is where we have a stagflation scenario so what are the causes of cost push inflation well this is an increase in the cost of production so wages increase you could have rents increasing you could have an increase in corporation tax or any tax associated with running a business cost push inflation occurs when the price of raw materials increases so when commodities go up in price because if a company is importing a commodity to use to create something else with then a rise in the price of the raw materials is going to lead to greater costs and companies will be fairly quick usually to actually pass these costs on to the consumer this is why we see a rise in prices when we have a shift to the left in short run aggregate supply now don’t forget also a decrease in the value of the exchange rate can also cause some cost push inflation because this is simply another way of looking at a rise in the price of raw materials if the price of raw material stays the same but you can buy less raw materials with the same dollar than you could a year ago then this is a hidden cost the price of the raw materials may have stayed the same but perhaps it takes more dollars today to buy the same amount of raw materials as it did previously so the cost of raw materials has actually gone up because of the devaluation in the exchange rate