Question

Identify the two descriptions below as being the result of either cost-push inflation or demand-pull inflation.

a. Real GDP is below the full-employment level and prices have risen recently.

b. Real GDP is above the full-employment level and prices have risen recently.

Short answer

a. Result of cost-push inflation.

b. Result of demand-pull inflation.

Step-by-step solution

The explanation for (a)

The cost-push inflation refers to a situation when a constant rise in input prices causes the output level to decline. For example, let us consider that there has been a rise in oil prices in the global market. It will lead to a hike in transportation costs and other essential inputs. Therefore the producers would employ fewer inputs and produce less output due to a rise in the cost of production.

Hence the real GDP level would fall below the full employment level with a simultaneous rise in the price level as a result of cost-push inflation.

The explanation for (b)

The demand-pull inflation refers to a situation when an increase in aggregate demand causes the price and output level to rise simultaneously in the economy. For example, if an economy begins from full employment conditions, an overall increase in demand for commodities causes the aggregate demand curve to shift rightwards. So the output level rises above the potential level, and the price level also increases.

Hence the real GDP level rises above the full employment level with a simultaneous rise in the price level due to demand-pull inflation.