Economists often say that inflation is the result of “too much money chasing too few goods”. This means that demand across the economy is rising more quickly than supply.

 

There are therefore two main reasons why prices increase:

Let’s look at these in more detail.

Economists often say that inflation is the result of “too much money chasing too few goods”. This means that demand across the economy is rising more quickly than supply.

 

There are therefore two main reasons why prices increase:

Let’s look at these in more detail.

Cost-push inflation
Increases in the costs of imported inputs, other raw materials or wages raise costs for all businesses. To cope with higher costs, firms may reduce their production of goods and services. In other words, aggregate supply in the economy will decrease.

 

If aggregate demand does not change, there will be a shortage of supply relative to demand. The higher production costs that businesses are facing will be passed on to consumers as higher prices. This results in cost-push inflation.

Demand-pull inflation
When the economy, jobs, and wages are growing at a healthy pace, consumers feel confident to spend. As a result, aggregate demand increases. If aggregate supply does not change, there will be an excess of demand relative to supply. Businesses across the economy are likely to increase prices, as strong demand means buyers are willing and able to pay more for goods and services that are in short supply. This is called demand-pull inflation.