Home > Economics FAQs Blogs > Why is demand-pull inflation more likely when aggregate supply is inelastic?
This question pertains to topics in Macroeconomics, such as Aggregate Demand and Supply and Inflation.
Demand-Pull Inflation: This is a type of inflation that results from an increase in aggregate demand, which can be caused by factors such as increased consumer spending, increased investment, or increased government spending.
Aggregate Supply Inelastic: Aggregate supply is considered inelastic when the quantity supplied is relatively unresponsive to changes in the price level. This is often the case in the short run, where there are fixed factors of production.
When
aggregate supply is inelastic, it means that producers cannot easily increase their output in response to increased demand. This could be due to limitations in production capacity, lack of available resources, or other constraints.
In this situation, if aggregate demand increases (e.g., due to increased government spending, increased consumer confidence, or other factors), it results in a greater increase in the price level compared to the quantity of goods and services produced.
The demand is pulling the price level up, resulting in demand-pull inflation.
This is because the demand exceeds the economy's capacity to produce. The limited supply with an increase in demand creates upward pressure on prices, leading to inflation.
Oil Industry: The oil industry is a good example of an industry with inelastic supply in the short run. If global demand for oil increases rapidly, oil-producing countries can't immediately increase their production due to factors such as geological constraints and the time it takes to extract and refine oil. This can lead to higher oil prices, contributing to demand-pull inflation.
UK Housing Market: In the UK housing market, supply can be relatively inelastic due to planning restrictions and time it takes to build new homes. If there is a sudden increase in demand for homes – for example, due to lower interest rates or government incentives for first-time buyers – this can lead to rapidly rising house prices, another form of demand-pull inflation.
Demand-pull inflation is more likely to occur when aggregate supply is inelastic. This is because an increase in demand in an economy where supply can't keep up leads to a rapid increase in prices, as is often observed in industries like oil and housing. In these situations, the increased demand pulls up the price level, resulting in inflation.
