2.4.1.2 Causes of inflation: cost push and demand pull

Causes of inflation can be broadly classified into two main categories: cost-push inflation and demand-pull inflation. Both of these types of inflation arise from different underlying factors and economic conditions. Let’s explore each cause:

Cost-Push Inflation: Cost-push inflation occurs when the costs of production, such as wages, raw materials, or energy, increase, leading to higher prices for goods and services. The increase in production costs reduces the aggregate supply in the economy, forcing businesses to raise prices to maintain profit margins.

Common factors contributing to cost-push inflation include:

Increase in Wages: When wages rise, it directly impacts production costs for businesses. If wages increase faster than productivity, businesses may pass on these higher labor costs to consumers through higher prices.
Higher Raw Material Prices: An increase in the cost of raw materials, such as oil, metals, or agricultural products, can lead to cost-push inflation, especially in industries heavily reliant on these inputs.
Supply Chain Disruptions: Disruptions in the supply chain, such as transportation bottlenecks or scarcity of critical inputs, can cause temporary increases in production costs, which may result in higher prices for end products.
Government Regulations and Taxes: Changes in regulations or taxes that directly affect businesses can increase their operating costs and lead to higher prices for consumers.

Demand-Pull Inflation: Demand-pull inflation occurs when the total demand for goods and services in an economy outpaces the economy’s productive capacity to supply those goods and services. In this situation, excess demand leads to upward pressure on prices, as businesses respond by increasing prices to balance supply and demand.

Common factors contributing to demand-pull inflation include:

Strong Consumer Spending: When consumers have high disposable income and are confident about the economy’s future, they tend to increase their spending, driving up demand for goods and services.
Expansionary Monetary Policy: Central banks may pursue expansionary monetary policies, such as lowering interest rates or increasing the money supply, to stimulate borrowing and spending. This increased spending can lead to demand-pull inflation.
Government Spending: An increase in government spending, particularly when funded by borrowing or money creation, can boost aggregate demand and contribute to inflationary pressures.
Export Demand: Strong demand for a country’s exports can lead to an increase in production and higher prices for goods and services, especially if the export sector is a significant part of the economy.