A
situation where total demand for goods and services continuously exceed the
total supply of goods and services at current prices is defined as Demand pull inflation . When an
economy is operating full employment, it is not possible to increase the supply
to meet the increased demand for goods and services; hence it will result in
rise in price level.
In
the following diagram explain this concept. After attaining full
employment of all resources at Point E supply curve becomes a vertical
straight line (perfectly inelastic). When there is shift in demand from D1
to D2 is followed by an increase in output, but when demand
increase to D3, as supply cannot be increased price level
increases.
The
following are the possible reasons for
demand pull inflation:
(1)
War time condition: When
resources are diverted from consumer production to defence production. This
leads to shortage and cause price level to increase.
(2) More exports: When income from
exports increase this will in turn increase the demand. On the other side
exports decreases the supply at home, so the excess demand pull the prices up.
(3)
Economic growth: Economic growth
requires production of capital goods by sacrificing consumer goods. As a result
price level also will rise.
(4)
Increase in government spending:
Increased government spending at full employment leads to increase in price
level.
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