4.6.4—Causes of inflation

Demand-pull inflation occurs when aggregate demand grows faster than the economy’s ability to supply output. Cost-push inflation follows higher unit costs, such as wages, energy or imported inputs.

Expectations can make either process persistent: workers and firms adjust wages and prices when they expect inflation. Imported inflation depends on exchange rates and foreign prices. Identify the initiating shock before naming the mechanism.

A consumer-spending boom can move AD right and raise the price level. A sudden energy-price rise can shift SRAS left, creating higher prices with weaker output—the pattern called stagflation.

Not every price rise is economy-wide inflation, and a one-off tax change may raise the price level without creating a continuing inflation process.