Question

1. Illustrate and explain using two (2) diagrams, the difference between demand-pull and cost-push inflation;

          (1 mark for each diagram plus 1 mark for each explanation)

2. Provide two examples or causes of each type of inflation.

          (1 for each example or cause: totals 4 marks)

3. Illustrate and explain using a diagram, how these two forms of inflation interact with each other.

Answer 1

Demand-pull inflation results from the shift in the aggregate demand curve to the right which raises the general price level and the real GDP. Cost-push inflation results from the shift in the aggregate supply curve to the left which raises the general price level but reduces the real GDP

Demand pull inflation

Cost push inflation

Demand pull inflation can be the result of an optimistic economic environment that raises consumption and investment spending. It also occurs when the taxes are reduced which raises disposable income and again, consumption and investment. Cost push inflation can result from increase in wages of workers as well as an increase in oil prices.

Demand pull inflation and Cost push inflation both cause the general price level to increase but one decreases the GDP while the other increases it. Demand pull inflation results when there is excess demand for goods and services than the economy can produce. Cost associated with labor, raw materials and other inputs when rises for the economy as a whole, results in cost-pull inflation. If both occur at the same time, there will be a rightward shift in AD and a leftward shift in AS