Demand-pull inflation occurs when a booming economy leads to increased demand for goods and services, causing prices to rise. This is caused by more people earning money and wanting to spend it on products they couldn’t afford when unemployed. However, the effects are generally short-term and the economy adjusts quickly after peak consumer demand has ended.
There can be far too much good when it comes to economic growth, and the concept of demand-pulling inflation bears this out. Demand-driven inflation explains why some items or services increase in price even when they appear to be in abundance. A booming economy means factories are hiring more workers, and those workers are producing more products. However, these additional employees are also making more money and want to spend that money on products they may not be able to afford when they are unemployed or underemployed. As the demand for these products increases but the supply cannot be increased fast enough to meet it, the price of the products often increases. This rise in prices during seemingly strong economic times is called demand-pull inflation by those who ascribe to the Keynesian economic model.
Demand-driven inflation is often described by many sources as “too much money chasing too many goods,” which is a very apt description of the situation. When unemployment rates are low, which is usually seen as a positive step for a nation’s economy, the number of people earning money increases. These workers are often responsible for producing high-demand consumer goods, such as popular toys or electronic devices, or processed foods. Ironically, workers who struggle to meet the demand for their products are also consumers who create greater demands for other goods and services. Even though supply of a product may be higher than ever before, increased demand from a larger pool of workers creates demand-pulling inflation.
Fortunately for consumers, the effects of demand-driven inflation are generally short-term. Once demand for a popular toy dries up after a holiday season, for example, the company has time to replenish supply and the price for that toy generally falls. If the unemployment rate were to rise, the demand for a product could decrease as fewer consumers can now afford to buy it. During times of demand-pulling inflation, aggregate supply is rarely low, simply unable to keep up with aggregate demand caused by higher employee spending.
Demand-driven inflation is often seen as the flip side of inflation, which creates higher prices due to an increase in the cost of raw materials or labor. Since the costs of producing goods are generally not a factor in inflation driving demand, the economy usually adjusts quickly after peak consumer demand has ended. On the other hand, the conditions that cause inflation in terms of cost drawdown can last for months or even years if labor or materials issues are not successfully addressed. Demand-driven inflation is a problem that many economies around the world wouldn’t mind experiencing, as it only occurs when gross national product (GNP) is rising and the employment rate is falling.
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