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Explain the differences between demand-pull inflation theories that say (1) consumers...

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bkhbkbhjb | Student, Undergraduate | eNotes Newbie

Posted May 23, 2010 at 6:18 AM via web

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Explain the differences between demand-pull inflation theories that say (1) consumers bid up or (2) business cost increases drive up prices?

I am a bit confused by the following discrepancy: some economists say that demand-pull inflation results because with an increase in the money supply, that leads to a shortage and then prices rise. On the other hand, other economists say this: the money supply rises and since peope are demanding more goods and services, businesses must hire more workers to keep up with the increase in demand. Therefore, since costs rise, then the sellers pass those increased costs on to the consumer in the form of higher prices. So my question is as follows: Why does one economist say demand-pull inflation results because consumers bid up the prices and the other economists say that since businesses have to hire more workers and costs increase, then sellers are forced to raise prices. Which one is the truth?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted May 23, 2010 at 6:30 AM (Answer #1)

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I think that what is going on here is that the first line of reasoning that you mention is a simpler model and the second line of reasoning is a more complicated one.

Both of these explanations are valid.  If there are more dollars seeking the same number of goods and services, the price of those goods and services will go up.  This is the simple way of looking at things.

A more involved way of looking at this examines the impact of AD on producers.  They have to hire more people and face diminishing returns and higer per-unit costs.  This is a more complicated analysis.

Both of these things are going on.  Different economists talk about different aspects depending on how complex they are trying to be.

You can look at the link below -- scroll down to "causes" to see a similar argument in different words.

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