Cost Push vs Demand Pull Inflation

Inflation – there are 2 types, cost-push and demand-pull.

Let me explain.
Inflation is inherent to any financial concepts and money issues around us. I can assure you that you and me have definitely encountered the effects of inflation on daily basis.

Cost-Push Inflation = a decrease in aggregate supply

Cause

a) Increase in labor and overhead cost
b) Increase in raw material prices as they become more scarce

Explanation
Because the production costs have increased, producer has 2 choices – either to produce less quantity, or decrease wage rates to retain the price, while still remains profitable. The former is usually not desirable or financially viable.

Unfortunately, when wage rates cannot be reduced anymore, while the same volume or more is needed, consumer will have to bear the cost of this price increase.
The indicator for this is Producer Price Index (PPI)

Examples

  1. Iphones and Ipads are being outsourced for mass production at Foxconn China due to low labour cost.
  2. Manufacturing plants for US companies are set up in Penang instead of in the States because comparatively, salary paid to an equivalent job level will be higher in the States.
  3. Surge in timber demand and prices post Japan tsunami

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Demand-Pull Inflation = an increase in aggregate demand

Cause

b) Increase in price level of goods in the rest of the world

Explanation
Increase in money supply has to do with consumer spending. When more people can afford and willing to purchase goods, the available supply in the market become lesser if production output cannot keep out with increasing demand. When something become scarce, only the highest bidder can possess it. From the seller financial perspective, he can afford to sell his goods at a higher bargain price.
The second causes has to do with diminishing purchasing power of a nation relative to the rest of the world. It means if our foreign exchange rate (and economy) is weak, it would cost us more to buy imported goods.

Examples

  1. Land is scarce in the Penang island, yet, more people desire to stay in Penang as the population grows. As a result, housing developers can charge a premium selling price for landed properties.
  2. An imported item from United States will cost more in 2009 when the exchange rate is RM 3.50/U$ compared to current home currency of RM 3.00/U$.

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