Types of Inflation

Different Types of Inflation

Strictly speaking, the different types of inflation are demand-pull inflation and cost-push inflation. Any inflation you encounter comes from either of these two types.

Let's briefly explain what each type of inflation is. As the name suggests, demand-pull inflation is inflation that results from excess demand that cannot be matched by production. So, demand is virtually pulling the prices up.

On the other hand, cost-push inflation is inflation that results from an increase in production costs. As production costs increase, producers are able to make less output. This drop in supply results in an increase in prices.

Demand-pull Inflation

Now, let's go into the details of demand-pull inflation. This one happens when all resources or factors of production are employed in the economy, yet, demand still exceeds what the economy can produce. It happens as people have a lot of money to spend, but they just cannot get enough goods to buy. So, the producers decide, well, if everybody has a lot of money, then let's raise the prices, and those who really need the products will buy them.

Demand-pull inflation happens when the central bank issues too much money. From this point on, there is a lot of money to spend, and businesses are unable to keep up with the demand. So, they increase prices. You'll not be asking for more products if you run out of money, right? Figure 1 shows demand-pull inflation.

Fig. 1 - Demand-pull Inflation

The graph shows output (as measured by real GDP) on the horizontal axis and aggregate price level on the vertical axis. Notice how the aggregate demand (AD) curve shifts to the right (from AD₁ to AD₂), resulting in an increase in the aggregate price level from P₁ to P₂.

Cost-push Inflation

Cost-push inflation is inflation that is triggered by high costs. This description puts it too simply, so let's go into some detail. This type of inflation is a result of increases in production costs. If the cost per unit of output increases and producers need to continue making profits, they will increase the prices of the output accordingly.

Economists refer to this cost as the per-unit production cost. It is calculated as the average cost of a given output level.

\(\hbox{Per-unit production cost}=\frac{\hbox{Total input cost}}{\hbox{Quantity of output}}\)

If the previous per-unit production cost is less than the current per-unit production cost, then cost-push inflation is triggered, and the general price level goes up. Figure 2 shows cost-push inflation.

Fig. 2 - Cost-push Inflation

The cost-push inflation graph also shows output or real GDP on the horizontal axis and aggregate price level on the vertical axis. In this case, take note of how the short-run aggregate supply (SRAS) curve shifts to the left (from SRAS₁ to SRAS₂), resulting in an increase in the aggregate price level from P₁ to P₂.

Other Types of Inflation

Built-in inflation is not necessarily a type of inflation since it has to come from either demand-pull inflation or cost-pull inflation. But it's interesting and important to know, so let's discuss it.

Hyperinflation is another interesting one, it's inflation, but inflation is so fast that the prices go up before the previous increase has the chance to settle in. Let's discuss it.

Types of Inflation and Example

Here, let's look at an example for each type of inflation. First, consider this example of demand-pull inflation.

In the above example, we can see that the government has given out money, but production is down anyway, so producers will increase the prices of the few products available due to the excess demand.

Now, let's look at this example of cost-push inflation.

In the above example, crude oil is the resource that has caused the increase in the per-unit production cost of fuels. This results in cost-push inflation.

Now, let's look at the inflation rate of the USA from 2012 to 2021 to give us a picture of real-life inflation.

Take a look at Figure 3 below.

Fig. 3 - USA Inflation Rate 2019-2022. Source: Bureau of Labor Statistics¹

Figure 3 above illustrates the fluctuations in the inflation rate of the USA from 2019 to 2022. It can be seen that the inflation rate fluctuated between 2.2 and 6 percent. The significant rise in inflation rate after 2019 is due to the significant decline in production and household spending during the Covid-19 pandemic. Essentially, this is a demand-pull inflation since there is high demand post-pandemic which suppliers are struggling to meet, since they did not produce enough during the pandemic.