Causes of inflation Demand pull inflation

Inflation is caused by:-

Cost push inflation
Demand pull inflation
Inflation expectations

1. Demand Pull Inflation
Demand-pull inflation is likely when there is full employment of resources and when
SRAS is inelastic.
If this occurs then an increase in AD will lead to an increase in prices.
AD might rise for a number of reasons some of which occur together at the same
moment of the economic cycle

2. A depreciation of the exchange rate

This has the effect of increasing the price of imports and reduces the foreign price of UK

If consumers buy fewer imports, while foreigners buy more exports, AD will rise.

If the economy is already at full employment, prices are pulled upwards.

3. A reduction in direct or indirect taxation.

If direct taxes are reduced consumers have more real disposable income causing
demand to rise.

A reduction in indirect taxes will mean that a given amount of income will now buy a
greater real volume of goods and services.

Both factors can take aggregate demand and real GDP higher and beyond potential GDP.

4. The rapid growth of the money supply

If interest rates are low more money is borrowed leading to more consumption and an
increase in AD

5. Rising consumer confidence

Leads to an increase in total household demand for goods and services

6. Faster economic growth in other countries

Provides a boost to UK exports overseas.

Inflationary gaps

As AD increase AS becomes less elastic forcing up prices
If AD goes beyond potential GDP ie the pressure for AD is beyond the LRAS curve then
an inflationary gap appears which forces factor prices higher.
The effect of this is to cause an inward shift of SRAS taking real national output back
towards a macroeconomic equilibrium at Yfc but with the general price level higher than it
was before.