Question 18 (1 point)
Demand-pull inflation:
occurs when prices of resources rise, pushing up costs and the price level.
occurs when total spending exceeds the economy’s ability to provide output at the existing occurs only when the economy has reached its absolute production capacity. is also called cost-push inflation.
The Correct Answer and Explanation is:
Correct Answer:
occurs when total spending exceeds the economy’s ability to provide output at the existing price level.
Explanation (≈300 words):
Demand-pull inflation is a type of inflation that occurs when aggregate demand (total spending in the economy) surpasses aggregate supply at the current price level. In simple terms, it happens when too much money chases too few goods. As demand rises and outpaces the economy’s productive capacity, prices begin to increase.
This situation commonly arises during periods of strong economic growth when consumers, businesses, and governments increase their spending. For example, if consumers have more disposable income, businesses invest heavily, and the government increases spending (perhaps through stimulus programs), the combined effect increases overall demand. If the economy is already operating near or at full capacity, it cannot increase output fast enough to meet the rising demand. As a result, producers respond by raising prices, leading to demand-pull inflation.
Demand-pull inflation is often associated with a booming economy. For instance, during economic expansions, employment and incomes rise, and consumer confidence increases. These factors encourage higher spending, which contributes to higher demand for goods and services.
Unlike cost-push inflation, which is driven by increasing production costs (e.g., wages, raw materials), demand-pull inflation originates from the demand side of the economy. It reflects a shift of the aggregate demand curve to the right on the aggregate supply and demand graph.
In essence, demand-pull inflation can occur before the economy reaches its maximum productive capacity but becomes particularly acute when the economy is near or at full employment, where resources (like labor and capital) are fully utilized.
Central banks often monitor demand-pull inflation closely. To manage it, they may use contractionary monetary policy, such as raising interest rates, to reduce spending and slow down inflationary pressure.
Thus, the correct understanding of demand-pull inflation highlights the importance of maintaining a balance between total spending and the economy’s capacity to produce goods and services.
