MACRO – DEMAND-PULL INFLATION

Definition
Demand-pull inflation is the state achieved when the total demand in an economy is
higher than the total supply. The Aggregate demand comes from households, businesses,
governments and foreign buyers.
Demand-pull inflation is set in motion when consumer demand increases. Normally,
sellers will meet this increase by increasing their supply to match demand. Yet when demand
outpaces supply, sellers will raise prices as a result. This price hike is called demand-pull
inflation, and it’s the most common type of inflation in economics.
The root cause of Demand-pull inflations is when Aggregate demand exceeds
Aggregate Supply. The large demand but small supply in this economic state results in “too
much money chasing too few goods”. It occurs when economic growth is too fast.
Or simply, if goods are limited at a time when people are willing to spend more
money, competition among consumers drives prices up.

Graph - If the productive capacity (AS) doesn’t rise as quickly as aggregate demand (AD),
then firms will respond by increasing prices, which creates inflation.
In a model of aggregate demand-aggregate supply, it occurs when the aggregate demand
curve shifts to the right because demand of consumers increase. As a result, the price level
increased from P to P1, and Aggregate output also rise from Y to Y1.

Examples of demand-pull inflation

We will talk about Covid-19 Pandemic Demand
When the Covid-19 pandemic first broke out, Vietnamese people bought medical
masks in large quantities, causing the demand for this item to increase rapidly while the
supply is not enough to meet the demand, just as the company’s production was frozen
because of Covid-19. This led the price of medical masks to double and almost triple.

What causes demand-pull inflation?

1. Economic growth and increased consumption

When the economy is booming and unemployment is low, consumers tend to earn more
income and spend more money, which drives up levels of aggregate demand throughout an
economy.

2. Inflation expectations.
Expectations of Inflation in the future can also contribute to demand-pull inflation. If
consumers expect prices to continue increasing, they will be willing to pay more now so that
they can remain competitive in the future. 

3. Government spending.

The government can also play a role in causing demand-pull inflation by increasing its
spending. When the government spends more money, it increases the amount of money in
circulation and puts pressure on prices to rise.

4. Money supply

If the money supply is increased by the central bank, consumer spending and aggregate
demand increase as well. When there is more money available to spend, each dollar has less
purchasing power. Demand-pull inflation can result when this happens because consumers
will be willing to pay more for goods and services than before as they have access to more
money with which to make purchases.

Conclusion
If demand-pull inflation is driven by elevated demand for goods or services, cost-push
inflation is when a supply shortage leads to higher prices.
How does demand-pull inflation create higher prices?

Demand-pull inflation creates higher prices, because it shifts the demand curve to the right.
More buyers want more products and services. If the supply doesn't increase proportionally to
demand, then buyers will pay higher prices for the limited supply.