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DISEQUILIBRIUM, LONG-RUN AGGREGATE MARKET: The state of the long-run aggregate market in which real aggregate expenditures are NOT equal to full-employment real production, which result in imbalances that induce changes in the price level. In other words, the opposing forces of aggregate demand (the buyers) and long-run aggregate supply (the sellers) are out of balance. Either the four macroeconomic sector (households, business, government, and foreign) buyers are unable to purchase all of the real production that they seek at the existing price level or business-sector producers are unable to sell all of the full-employment real production that they have available at the existing price level.

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INFLATION CAUSES:

Inflation, the persistent increase in the average price level, can be caused by an increase in aggregate demand or a decrease in aggregate supply. This suggests two basics sources, causes, or types of inflation--demand-pull inflation and cost-push inflation. While short-term bouts of inflation (up to several months) can result from anything (determinant) that might cause either increases in aggregate demand or decreases in aggregate supply, long-term inflation (a year or more) is possible ONLY through persistent increases in the money supply. As such, while demand-pull inflation and cost-push inflation are convenient ways to catalog the transmission mechanisms of inflation, the ultimate CAUSE of inflation is money.
The causes of inflation are conveniently analyzed within the framework of a simple market. In general, prices increase as a result of market shortages, which occur when quantity demanded exceeds quantity supplied. Market shortages can be created by either increases in demand or decreases in supply. Translating this to the macroeconomy suggests that inflation occurs when aggregate demand exceeds aggregate supply. Inflation-inducing, economy-wide shortages can be created by either increases in aggregate demand or decreases in aggregate supply.

This analysis suggests the two basic types of inflation: demand-pull inflation and cost-push inflation. Demand-pull inflation, as the name indicates, results when economy-wide shortages are created by increases in aggregate demand. Cost-push inflation results when economy-wide shortages are created by decreases in aggregate supply, which are so named because they are more often than not triggered by increases in production cost.

Demand-Pull Inflation

Demand-pull inflation places responsibility for inflation squarely on the shoulders of increases in aggregate demand. 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.
  • 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.
In general, if aggregate demand increases beyond aggregate supply, buyers seek to buy more production than the economy can provide. The buyers bid up the price. This extra demand "pulls" the price level higher.

Any increase in aggregate demand resulting from changes in any of the aggregate demand determinants can trigger demand-pull inflation. However, the only way to sustain demand-pull inflation is with an increase in the money supply. In fact, one of the best documented relationships 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.

Cost-Push Inflation

Cost-push inflation places responsibility for inflation directly on the shoulders of decreases in aggregate supply that result from increases in production cost. This type of inflation occurs when the cost of using any of the four factors of production (labor, capital, land, or entrepreneurship) increases.
  • In terms of the production possibilities analysis, this means that the production possibilities frontier is shrinking closer to the origin, causing it to bump down against the aggregate demand. The end result is inflation.

  • In the aggregate market analysis, aggregate supply decreases to less than aggregate demand creating economy-wide shortages. As with any market shortage, the price (price level) rises. The end result is inflation.
In general, higher production cost means the economy simply cannot continue to supply the same production at the same price level. If buyers want the production, they must pay higher prices. The higher cost "pushes" the price level higher.

While any of the factors of production "could" trigger cost-push inflation, labor and land are the two factors most likely to do so--especially wages and energy prices. However, like demand-pull inflation, cost-push inflation can be sustained only if the economy has more MONEY available.

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Recommended Citation:

INFLATION CAUSES, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2019. [Accessed: January 20, 2019].


Check Out These Related Terms...

     | demand-pull inflation | 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 |


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 demand increase, short-run aggregate market | aggregate demand increase, long-run aggregate market | inflationary gap | fiscal policy | monetary policy | money supply, aggregate demand determinant | inflationary expectations, aggregate demand determinant | energy prices, aggregate supply determinant | wages, aggregate supply determinant |


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     | Bureau of Economic Analysis | Bureau of Labor Statistics |


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