Question

Question 3:
(10 marks total - 2.5 marks each part)
(a) Illustrate and explain with diagrams the difference between demand-pull and cost-push inflation; (2.5 marks for the diagram and 2.5 marks for the explanation);
(b) Provide (describe) two (2) causes of each type of inflation
(2.5 marks for 2 demand-pull causes and 2.5 marks for 2 cost-push causes)

Answer 1

Ans

In figure 1 AS and AD are initial Aggregate supply and Aggregate demand respectively. Now an increase in cost of production shifts short run Aggregate supply to SRASo. As a result prices rise from p to p1. Since it happens due to cost increase this type of inflation is called cost push inflation

Demand pull inflation is shown in figure 2.Here prices rise from po to p1 because Aggregate demand rises from AD to AD1.

2 Cosh push inflation occurs due to increase in taxes or increase in prices of some inputs like crude oil

Demand pull inflation occurs due to higher wages of labour which thus demand more goods and services, increase in Govt expenditure

Answer 2

 Demand-Pull vs. Cost-Push Inflation

(a) Diagram and Explanation

1. Demand-Pull Inflation:

• Diagram:

  Copy

  Price Level (P) ▲
                 │
           SRAS  │
  P2 ────────╱   │
             │   │
  P1 ────────┼───┤
             │   │
             │   └───────────►
                             Real GDP (Y)

• Shift: AD curve shifts right (e.g., due to higher consumer spending).

• Result: Higher price level (P1 → P2) and increased output (Y1 → Y2).

• Explanation:
  Occurs when aggregate demand (AD) outpaces aggregate supply (AS), driving up prices.

• 
  

2. Cost-Push Inflation:

• Diagram:

  Copy

  Price Level (P) ▲
                 │
           SRAS' │
  P2 ────────╲   │
             │   │
  P1 ────────┼───┤
             │   │
             │   └───────────►
                             Real GDP (Y)

• Shift: SRAS curve shifts left (e.g., due to higher oil prices).

• Result: Higher price level (P1 → P2) but lower output (Y1 → Y2).

• 
  

• Explanation:
  Caused by rising production costs, reducing AS and increasing prices.

• 
  

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(b) Causes of Each Inflation Type

Demand-Pull Causes (2.5 marks):

1. Increased Consumer Spending:

• Example: Economic boom raises disposable income.

• 
  

2. Expansionary Fiscal/Monetary Policy:

• Example: Government stimulus checks or lower interest rates.

• 
  

Cost-Push Causes (2.5 marks):

1. Rising Input Costs:

• Example: Surge in oil prices increases transportation/production costs.

• 
  

2. Supply Chain Disruptions:

• Example: Natural disasters reducing raw material availability.

• 
  

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Key Takeaways:

• Demand-pull: "Too much money chasing too few goods."

• Cost-push: "Higher costs force prices up."