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Difference between demand inflation and cost inflation

Inflation refers to the rate at which the overall prices of goods and services increase with a consequent decrease in the purchasing power of the common man, which can be measured through the consumer price index. Modern inflation analysis revealed that mainly caused by the demand side or the supply side or both. The factors of the side of the demand lead to demand-driven inflation, while supply side factors lead to cost-driven inflation .

Inflation generated by demand occurs when aggregate demand is higher than aggregate supply in an economy, while inflation driven by costs occurs when aggregate demand is higher and the drop in aggregate supply due to external factors will determine a increase in the price level. This article clearly explains the significant difference between demand inflation and cost push.

Comparative chart

Basis for comparison Inflation demanded Cost inflation
SenseWhen aggregate demand increases at a faster rate than aggregate supply, known as demand call inflation.When there is an increase in the price of the inputs, with a consequent decrease in the output offer, known as cost inflation.
representsHow does price inflation start?Why is inflation so hard to stop once it starts?
Caused byMonetary and real factors.Monopolistic groups of society.
Policy recommendationsMonetary and fiscal measuresAdministrative control over price increases and income policy.

Definition of Demand-Pull inflation

Demand Pull Inflation occurs when aggregate demand rises rapidly compared to aggregate supply in an economy. In simple terms, it is a type of inflation that occurs when the aggregate demand for products and services exceeds the aggregate supply due to monetary factors and / or real factors.

  • Inflation due to monetary factors : one of the main causes of inflation; increase in the money supply compared to the increase in the level of production. German inflation, in the year 1922-23, is the example of demand-driven inflation caused by monetary expansion.
  • Inflation due to real factors : when inflation due to one or more of the following reasons, it is said to be caused by real factors:
    • The increase in public expenditure without the change in tax revenues.
    • Tax rates fall, without any change in public spending
    • Increase in investments
    • Decreased savings
    • Increase in exports
    • Decreased imports

Of these six factors, the first four factors, will determine the increase in the level of disposable income. The increase in aggregate income translates into the increase in aggregate demand for goods and services, causing chain inflation in demand.

Definition of Cost-Push inflation

Cost-driven inflation means the rise in the general price level caused by the rise in the prices of inputs, due to the scarcity of inputs, such as labor, raw materials, capital, etc. This translates into a decrease in the offer to mainly use these inputs. Thus, the rise in the prices of goods emerges from the supply side.

In addition, cost-driven inflation can also be caused by depletion of natural resources, monopoly, and so on. There are three types of cost-based inflation:

  • Wage inflation : when monopoly groups of society as unions exercise their monopoly power, to increase their monetary wages above the competitive level, which cause an increase in production costs.
  • Profit driven inflation : when monopolistic power is used by companies operating in the monopolistic and oligopolistic market to increase their profit margin, it leads to an increase in the price of goods and services.
  • Inflation to supply inflation : a type of inflation resulting from the unexpected drop in the supply of necessary consumer goods or important industrial production factors.

Key differences between demand inflation and cost push

The differences between dDemand-pull inflation and cost inflation can be clearly drawn from the following reasons:

  1. Inflation generated by demand arises when aggregate demand increases at a faster rate than aggregate supply. Cost-driven inflation is the result of an increase in the price of inputs due to the lack of production costs, which has led to a decrease in the output offer.
  2. Does demand-based inflation describe how price inflation starts? On the other hand, cost-driven inflation explains why inflation is so difficult to stop once it starts?
  3. The reason for inflation due to demand is the increase in the money supply, public spending and exchange rates. In contrast, cost-based inflation mainly caused by the company's monopolistic groups.
  4. The policy recommendation on inflation linked to the demand associated with the monetary and fiscal measure which corresponds to the high level of unemployment. Unlike cost-based inflation, where the policy recommendation related to administrative control over price increases and income policy, whose goal is to control inflation without increasing unemployment.

Conclusion

Therefore, it is possible to conclude with the above discussion the main reason for causing inflation in the economy or demand or cost push factors. It is often argued that the supreme factor of inflation, which one of the two-factor causes increases for the first time in the general price level. Experts believe that the demand push factor is the main inflation factor in any economy.