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July 16, 2018 

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FDI: The abbreviation for Foreign Direct Investment, this is the acquisition of controlling interest in foreign firms and businesses from one country in another country. FDI can also take the form of constructing factories, structures and equipment (or any form of physical capital) in foreign soil. FDI does not include foreign investment into the stock markets (portfolio investment). Most economists consider foreign direct investment more useful than portfolio investment since this last one is generally regarded as temporal and can leave the foreign country at the first sign of trouble. FDI on the other hand, is considered more durable and with larger economic (potential) benefits.

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DEMAND-PULL INFLATION:

Inflation that results from increases in aggregate demand that exceed any increases in aggregate supply. This type of inflation results when the four macroeconomic sectors (household, business, government, and foreign) collectively try to purchase more output than the economy is capable of producing. The alternative type of inflation is cost-push inflation.
Demand-pull inflation places responsibility for inflation squarely on the shoulders of increases in aggregate demand. In general, increasing aggregate demand means buyers want more production than the economy is able to provide. The end result is that buyers bid up the price of available production. The extra demand "pulls" the price level higher.
  • In terms of the simple production possibilities analysis, demand-pull inflation results when the economy bumps against, and tries to go beyond, the production possibilities frontier. The end result is inflation.

  • In the more elaborate aggregate market analysis, demand-pull inflation results when aggregate demand increases beyond aggregate supply creating economy-wide shortages. As with market shortages, the price (or price level) rises. The end result is inflation.
Demand-pull inflation can be triggered by any of the aggregate demand determinants.
  • It could be the result of an increase in consumption, perhaps brought about by a boost in consumer confidence or (strange is it might seem) expectations of future inflation.

  • It could be the result of an increase in investment caused by falling interest rates or expectations of a booming economy.

  • It could be the result of an increase in government spending or a decrease in taxes, either of which would boost deficit spending.

  • It could be an increase in exports to other nations or a decline in imports from other nations.
While any of these aggregate demand determinants can and have caused increases in aggregate demand, creating shortages in the aggregate market and higher price levels, the resulting inflation tends to be short-lived UNLESS the money supply also increases. The reason is that expenditures require money. If the money supply is fixed, then one sector can increase expenditures on aggregate supply ONLY if another sector reduces expenditures on aggregate supply.

Suppose, for example, that households decide to increase consumption expenditures because they expect inflation to increase and future prices will be higher. As such, they devote a larger share of their income to consumption and a smaller share to saving. But, if households save less, then the flow of funds used by business for investment expenditures and government for deficit financing is less. These sectors have less money to spend.

An increase in aggregate demand caused by an increase in consumption expenditures can temporarily trigger a higher price level, but eventually it will be countered by decreases in aggregate demand caused by decreases in investment expenditures and government purchases.

The only way to sustain demand-pull inflation is if the increase in the MONEY spent by one sector does NOT reduce the amount of MONEY available for spending by other sectors. And this can only happen if the economy has more MONEY. In fact, one of the best documented relations in economics is that between money and inflation. Inflation simply CANNOT persist for any extended period of time (that is, a year or more) without increases in the amount of money available to the economy.

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Recommended Citation:

DEMAND-PULL INFLATION, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2018. [Accessed: July 16, 2018].


Check Out These Related Terms...

     | inflation causes | cost-push inflation | price level | price index | deflation | disinflation | inflation problems | inflation rate | Consumer Price Index | GDP price deflator |


Or For A Little Background...

     | inflation | business cycles | shortage | expansion | macroeconomics | macroeconomic goals | macroeconomic problems | production possibilities | gross domestic product | real gross domestic product | nominal gross domestic product | aggregate demand determinants | aggregate expenditures | aggregate demand | money |


And For Further Study...

     | cost of living | Producer Price Index | Wholesale Price Index | CPI and GDP price deflator | unemployment | Bureau of Labor Statistics | Bureau of Economic Analysis | National Income and Product Accounts | circular flow | stabilization policies | production cost | unemployment reasons | aggregate market analysis | aggregate demand increase, short-run aggregate market | inflationary gap |


Related Websites (Will Open in New Window)...

     | Bureau of Economic Analysis | Bureau of Labor Statistics |


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