how demand pull inflation works
the term demand pull inflation describes a widespread phenomenon that occurs when consumer demand outpaces the available supply of many types of consumer goods when demand pull inflation sets in it forces an overall increase in the cost of living demand pull inflation is a tenet of keynesian economics that describes the effects of an imbalance in aggregate supply and demand when the aggregate demand in an economy strongly outweighs the aggregate supply prices go up this is the most common cause of inflation in keynesian economics an increase in employment leads to an increase in aggregate demand for consumer goods in response to the demand companies hire more people so that they can increase their output the more people firms hire the more employment increases eventually the demand for consumer goods outpaces the ability of manufacturers to supply them inflation is a general rise in the price of goods in an economy causes of demand pull inflationthere are five primary causes of demand pull inflation demand pull inflation vs cost push inflationcost push inflation occurs when money is transferred from one economic sector to another specifically an increase in production costs such as raw materials and wages inevitably is passed on to consumers in the form of higher prices for finished goods demand pull and cost push inflation move in practically the same way but they work on different aspects of the system demand pull inflation demonstrates the causes of price increases cost push inflation shows how inflation once it begins is difficult to stop in good times companies hire more but eventually higher consumer demand may outpace production capacity causing inflation example of demand pull inflationhere s a hypothetical example to show how demand pull inflation works let s assume the economy is in a boom period and the unemployment rate falls to a new low interest rates are at a low point too the federal government seeking to get more gas guzzling cars off the road initiated a special tax credit for buyers of fuel efficient cars the big auto companies are thrilled although they didn t anticipate such a confluence of upbeat factors all at once demand for many models of cars goes through the roof but the manufacturers literally can t make them fast enough the prices of the most popular models rise and bargains are rare the result is an increase in the average price of a new car it s not just cars that are affected though with almost everyone gainfully employed and borrowing rates at a low consumer spending on many goods increases beyond the available supply that s demand pull inflation in action 