What happens when sellers are unable to keep up with the demand for a product? This can lead to the imposition of higher prices, which is called demand-pull inflation. Find out more about the causes and effects of demand-pull inflation below.
Demand-pull inflation explained
When the aggregate demand for goods and services is higher than aggregate supply, this creates the situation of demand-pull inflation. Demand-pull inflation is set in motion when consumer demand increases. Normally, sellers will meet this increase by increasing their supply to match demand. Yet when demand outpaces supply, sellers will raise prices as a result. This price hike is called demand-pull inflation, and it’s the most common type of inflation in economics.
Demand-pull inflation vs. cost-push inflation
Although demand-pull inflation is the most common type, cost-push inflation also has an impact on world economies. Cost-push inflation happens when money transfers from one economic area to another. For example, an increase in production costs is transferred (or pushed) onto consumers. Whether it’s due to an increase in raw material prices or other production costs, this translates into higher prices for finished products.
While demand-pull inflation is related to increases in aggregate demand, cost-push relates to increases in production pricing. The two are not mutually exclusive, meaning they can often go hand-in-hand.
Causes of demand-pull inflation
There are five main causes of demand-pull inflation:
Growing economy: When the economy’s doing well, consumers feel more confident spending money rather than saving it. A growing economy leads to lower unemployment rates and a booming property market. This in turn creates a growth in demand for products and services.
Inflation expectation: If consumers expect inflation in the near future, they’re more likely to buy products now before a future price increase. This increases demand, which leads to demand-pull inflation.
Money supply expansion: If the government prints too much money to pay off debts, this leads to an oversupply of money in circulation. The same effect is caused if the government gives too much credit to the banking system.
Government spending: Government spending increases demand for certain products. Government policies like tax decreases also have an impact, because they give consumers a higher discretionary income for spending on goods and services. If this outpaces supply, it causes demand-pull inflation.
Asset inflation: Whether caused by savvy marketing or in-demand technology, certain products can experience periods of high, or inflated, demand. This allows brands to charge higher prices for their products.
Effects of demand-pull inflation
No matter the cause, there are certain economic effects of demand-pull inflation. The most noticeable is an imbalance in the usual relationship between supply and demand. Because production can’t keep up with consumer demand for any of the reasons outlined above, higher prices are the ultimate result. Like any type of inflation, this leads to effects such as the following:
Reduces purchasing power of consumers
Encourages spending to avoid impact of further inflation
Increases the cost of borrowing
Potential impact on currency rates
Continued inflation growth
How to control demand-pull inflation
To prevent inflation from spiralling out of control, governments and financial institutions have a few tools at their disposal. For example, a central bank might increase interest rates to counter demand-pull inflation, leading consumers to spend less on housing and products. This in turn lowers demand, allowing producers to catch up with supply and restoring balance.
Governments can also reduce government spending or raise taxes. When looking at how to control demand-pull inflation, it’s important to consider the various causes to choose the best course of action. Today’s global economy also helps keep demand-pull inflation in check, as consumers have access to an international marketplace of manufactured goods at varying prices.
We can help
GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.