Principles of Macroeconomics / Unit 8 MAC 0727 review, 2 to 3 minutes
Demand-Pull and Cost-Push in the Diagram
The idea
Unit six named two kinds of inflation. This diagram shows them, and shows why the distinction matters for what should be done. Demand-pull inflation is aggregate demand shifting right while the economy is at or near potential, in the steep zone of the supply curve. There is little spare capacity, so the extra spending cannot call out much extra output and mostly raises the price level instead. Output rises a little, the price level rises a lot, and unemployment falls below the natural rate. Cost-push inflation is short-run supply shifting left because input prices rose across the economy. Now the price level rises while output falls, so unemployment rises at the same time. The two are told apart by what happened to output, and they are told apart for a reason: the policies that help one make the other worse.
In practice
Worked example: an economy already at potential receives a large increase in spending. Prices rise, output barely moves, and the sensible response is to damp demand back down, which costs little output because there was little extra output to begin with. Now the same economy instead suffers a tripling of energy prices. Supply shifts left, prices rise and output falls. Damping demand here would lower prices but deepen the fall in output, while supporting demand would hold output up but push prices higher still. There is no move that improves both, which is what made the nineteen seventies so hard.
Where people slip
Three cautions. A single shift of either curve raises the price level once and then stops, so it is a one-time rise rather than ongoing inflation; sustained inflation needs demand shifting right repeatedly, or expectations that keep feeding into wages and prices. The diagram also cannot say which shift caused an episode when both happen together, which is usually what happens. And the labels describe the mechanism, not the blame: cost-push does not mean anyone chose to raise costs, and demand-pull does not mean anyone overspent irresponsibly.
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