Types of Inflation (Edexcel IGCSE Economics)

Demand Pull Inflation

• An increase in the average prices in an economy can be caused by demand-pull inflation or cost-push inflation

• Demand-pull inflation is caused by excess demand in the economy

  • This excess demand leads to higher prices as suppliers increase prices to balance the demand-supply gap

  • Excess demand is often caused by higher incomes, resulting in more money flowing around the economy

  • Factors that lead to higher incomes include:

    • Salary increases

    • Lower taxes raise disposable income

    • More government spending

    • Lower interest rates reduce interest payments, leading to an increase in disposable income

    • Higher employment levels

    • Increased exports generate more income in the country

Examples of demand pull inflation

• If the Central Bank lowers the base rate, there is likely to be increased borrowing by firms and consumers

  • This will result in an increase in consumption and investment

  • It is likely to lead to a form of demand-pull inflation

• If the government increases public spending or lowers taxes, people may have more money to spend, which could result in demand-pull inflation

Cost Push Inflation

• Cost push inflation is caused by increases in the costs of production in an economy

  • This can be a result of an increase in cost of raw materials, labour, or interest rates

  • It passes on the increased costs to consumers in the form of higher prices

  • E.g If there's a rise in oil prices, it will increase the cost of production for goods that rely on oil, leading to cost-push inflation

Impacts of Inflation

• The aim is to have a low and stable rate of inflation of approximately 2%, which means there is a steady rate of economic growth

• Higher levels of inflation have many negative impacts on firms, workers, consumers and the government

Impact of Inflation