Principles of Macroeconomics / Unit 6 MAC 0522 worked example, 60 to 90 seconds
Which Kind of Inflation?
The idea
The two kinds look alike in the price level and differ in everything else, so use output to tell them apart. Ask what moved first. If spending rose, whether from households, firms, government or abroad, it is demand-pull, and output rises with prices. If the cost of producing rose, from wages, materials, energy or a disruption to supply, it is cost-push, and output falls while prices rise. Rising prices with rising output is demand; rising prices with falling output is cost.
In practice
Worked example: a government cuts taxes and households spend the money while factories are already near capacity. Prices rise and output rises: demand-pull. Second case: a war closes a shipping route and the cost of every imported input jumps. Prices rise and output falls: cost-push. Third case: both happen at once, which is what most real episodes look like.
Where people slip
Expectations complicate both. If people expect inflation and act on it, by asking for higher wages or setting higher prices, the expectation helps bring about the inflation that was expected.
Your place on the trail
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