Last week, I discussed inflation in detail, and briefly mentioned the three different types of inflation: demand-pull, cost-push, and built-in inflation. Each variation has different causes, but the same result: a decrease in purchasing power. I don’t want inflation to be a cryptic and threatening word, so in this article, I’ll be explaining the first variation of inflation in detail, and in the following weeks, I’ll explain the other two.
First, let's quickly recap what inflation is. Inflation is a decrease in purchasing power, meaning one dollar will be able to buy less and less as time passes. Inflation has been present throughout recent history, and will likely remain present for years to come.
Inflation, in short, degrades the “value” of cash, so saving money in cash for long periods of time (decades) is harmful and not the best financial decision. However, inflation isn’t something to be too fearful of; in the short term, its effects are negligible, and in the long term, there are many ways to keep your money protected. I’ll discuss this more in a future article.
With that said, the first variation of inflation is demand-pull inflation. Demand-pull inflation, as the name suggests, is inflation caused by an increase in demand. This means consumers (people that buy goods) are buying more items (an increase in demand). Because consumers are purchasing more goods than companies can produce, many goods become limited, and therefore increase in price. A general increase in prices is a signal of inflation, as items are increasing in price without an accompanying increase in quality.
There are a few key reasons for this kind of inflation and they all revolve around increased spending. The first is low unemployment. While low unemployment is good, according to economic theory, a certain level of unemployment is normal (around 5%). This means that if unemployment is unnaturally low, more people than usual have jobs, meaning more people have money to spend. Because the number of consumers has increased, demand also increases, leading to certain goods becoming scarce - getting bought faster than they can get produced - which leads to an increase in prices.
Similarly, if the economy goes through a period of rapid expansion and strengthening, like after a Covid-19-esque event, there's an increase in consumption as buyers no longer have to worry and save money in fear of an economic collapse.
Additionally, if an increase in the money supply occurs, or if money becomes more accessible through credit, consumers are likely to spend more as they have access to more. This too, leads to increased demand, which outpaces supply, which, in turn, leads to increased prices.
In short, demand-pull inflation results from increased demand pulling prices up. Increased demand occurs for a number of reasons, most revolving around consumers having access to more money. When demand becomes abnormally high, companies struggle to keep production up to par, as items are getting bought faster than they get made. So, prices are increased.
I hope this article was helpful, thanks for reading, and I’ll catch you in the next one!