Question

Using two separate money demand and supply graphs, show how inflation (rise in P) can occur in two ways

Answer 1

1)Cost Pull Inflation

Cost push inflation is inflation caused by an increase in prices of inputs like labour, raw material, etc. The increased price of the factors of production leads to a decreased supply of these goods. While the demand remains constant, the prices of commodities increase causing a rise in the overall price level. This is in essence cost push inflation.

2)Demand Pull Inflation

Demand-pull inflation is when aggregate demand for a good or service outstrips aggregate supply. It starts with an increase in consumer demand. Typically, sellers meet such an increase with more supply. But when additional supply is unavailable, sellers raise their prices. That results in demand-pull inflation.