Answer to Question #31736 in Macroeconomics for dibin

Question

7. Distinguish between ongoing demand pull and ongoing cost push inflation. Carefully draw them. Why might it be difficult to establish the extent to which a given rate of inflation is either demand pull or cost push? (

Answer 1

Demand pull inflation is where the demand for an item has increased to a point where the price is increased, to reach an new equilibrium on a supply demand diagram. For example, if there is a toy many children want for christmas, sellers may increase the price.

Cost push inflation is where the price must be increased because the costs of making the product or service has increased, for example, if there was a new tax on raw material A, any products which use this raw material will have their price increased relative to the tax increase.

These can both occur at the same time, for example, if we look at the scenario of eg coal. Let's imagine there is a large increase in the demand for coal for whatever reason, the companies buying it from the mines are the customers of the mines, and demand pull inflation occurs, the price these companies sell coal at to the customer must be increased due to this demand pull inflation, inciting cost push inflation.

SO, it appears that it is not a good idea to 'depend' on one of either the monetary or fiscal policy, as it is better to use smaller changes in both to give a larger change in the economy.

If we were aiming to reduce unemployment, we wouldn't depend on a particular policy, we would have to look at supply side policies, the current state of the economy, eg recession, etc. We would do this because there are many factors to take into account before any change which would influence the economy.