Demand-pull inflation caused by increase in aggregate demand due to increased private and government spending, etc. Demand-pull inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion. The demand-pull inflation occurs when the aggregate demand exceeds the available supply of goods and Services in existence. The process of demand-pull inflation is when the supply of money increases, rate of interest falls. This increases the investment which increases money income. As a result, the expenditure on consumption goods and investment expenditure increases. Due to this, demand increases than supply and the demand-pull inflation occurs. This can be illustrated with the help of figure;
In the figure given above, ‘AS’ is the given aggregate supply curve of the economy and each aggregate demand curve (AD0 to AD4) Shows the level of aggregate demand associated with the rising levels of money income in the economy when aggregate demand increases from AD0 to AD2, output as well as prices increase. But as the level of full employment is reached at Qf and the supply curve becomes perfectly inelastic, increases in income beyond AD2 lead to what Keynes termed “true inflation”. The rise in prices upto P2 is called “bottleneck inflation”, which is due to imbalances, shortages and rising costs in the economy as the level of full employment is approached. Beyond the point E, the aggregate supply function is assumed to be vertical and prices are rising directly due to increases in the level of money income.
According to this concept, the inflation occurs when the demand further increases after reaching the state of full employment. In such situation aggregate demand will be more than the aggregate supply because after the state of full employment supply won’t increase despite the increase in demand. Thus, price of goods will increase. This is known as demand-pull inflation.
Causes of demand-pull inflation
Demand-pull inflation caused by the following factors:
(i) Increase in the quantity of money:
The demand for goods increases rapidly when the quantity of money increases rapidly in the economy. So, increase in demand due to increase, in the quantity of money creates the ‘demand-pull inflation’.
(ii) Increase in public expenditure:
In modern time, the government spends more than revenue due to the increase in government activities. This creates fiscal deficit. Some part of the deficit is met by the government by printing new notes on account of this the expansion of money increases and inflation occurs.
(iii) Reduction in taxation:
If the government reduces taxes, households are left with more disposable income in their pockets. This leads to increase consumer spending. Thus, increasing aggregate demand and eventually causing demand-pull inflation.
(iv) Shortage of goods and services:
The price level increases when the supply of goods and services is lower in relation to demand. The production and supply decrease due to the scarcity of factors of production, hoarding by businessmen, natural calamity, scarcity of raw-materials, etc.
(v) Redistribution of income:
Redistribution of income will increase the demand for goods and services. This is because increase in the income of the people will increase their propensity to consume. Increase in consumption will increase the demand which will lead to increase in price and the ‘demand-pull inflation’ will be resulted.