Chapter 12 Inflation In this chapter we look in more detail at the inflationary process.

To do this we introduce the aggregate demand curve and the aggregate supply curve and show how they determine the price level and the level of output, or GDP. If these curves shift, then in the same way as did the demand and supply curves we met in Chapter 2, they will alter the level of prices. Sustained shifts in the curves can thus explain inflation. Section 12.1 describes the aggregate demand curve and Section 12.2 describes the aggregate supply curve. In Section 12.3 we show the level of prices and GDP are simultaneously determined. Section 12.4 explains how demand-pull and cost-push inflation can arise. 12.1 Aggregate demand How does the aggregate demand for goods and services vary with the price level? Before we examine the causes of inflation (the rate of increase in prices) we need to look at how the level of process in the economy is determined. The level of prices in the economy is determined by the interaction of aggregate demand and aggregate demand and aggregate supply. The analysis is similar to that of demand and supply in individual markets, described in Chapter 2. There is one crucial difference, however, and this concerns price. When we looked at the supply and demand for (say) potatoes and plotted the price of potatoes on the vertical axis, we assumed that all other prices remained constant. In the aggregate case, it is the general price level of all domestic products that is plotted on the vertical axis. Similarly, the horizontal axis, in aggregate analysis, measures the total quantity of national output (or GDP). The aggregate demand curve As seen in Chapter 10, p. 248, aggregate demand (AD) is the total spending on the countrys products. It consists of four elements: consumer spending (C), private investment (I), government expenditure on goods and services (G), and expenditure on exports (X) less expenditure on imports (M). Thus: AD = C + I + G + X - M The aggregate demand curve shows how much GDP will be demanded at each level of prices. The curve is drawn in Figure 12.1. Why does the aggregate demand curve slope downwards? Why do people demand fewer products as prices rise? In Chapter 2, when the demand for an individual good was analysed, it was argued that when the price of a good rises consumers will purchase less of it, for two reasons: They cannot afford to buy so much. This is the income effect. The good is now more expensive relative to other goods. This is the substitution effect These two effects also operate in the aggregate case, although remember that here it is the general level of prices that increases.

Price level

AD 0

Figure 12.1 The aggregate demand curve

GDP

Income effects. For many people, when prices rise, their incomes will not rise in line with them, at least not in the short run. There will therefore be a redistribution of income away from wage earners (and hence consumers) to those charging the higher prices, namely firms. Thus for consumers there has been an income effect of the higher prices. The rise in prices leads to a cut in real income and consumption, and hence aggregate demand will fall. To some extent this may be offset by the effect of the rise in profits. However, it is unlikely that much of these additional profits will be firms on investment, given the fall in consumer spending; and any increase in dividends to shareholders will take a time before it is paid, and a large proportion of it is likely to be saved rather than spent. To summaries: if rise more than wages, the redistribution from wages to profits is likely to lead to a fall in aggregate demand. Clearly this income effect will not operate if wages rise in line with prices, for the real incomes of wage earners would be unaffected. In practice, in the short run wages typically do lag behind prices. An income is also likely to occur as a result of the income tax system. Income tax in Australia (as in most countries) is progressive. In other words, as peoples incomes rise with prices, they pay a larger proportion of their income in tax, partly because they are pushed into a higher tax band and partly because the tax-free threshold accounts for a smaller proportion of their income. As a result, they cannot afford to buy so much. Substitution effects. In the microeconomic situation, if the price of one good rises, people will switch to alternative goods. This is the substitution effect. But how can there be a substitution effect at a macroeconomic level? If prices in general go up, what can people substitution for spending? There are, in fact, three ways in which people can switch to alternatives. The first, and most obvious, concerns imports and exports. Higher prices for Australian exports discourage people overseas from buying them. At the same time, the price of imports falls relative to those of domestically produced goods and this causes people in Australia to buy more imports. Thus the figure for exports less imports (X-M) falls, and the higher price level has caused a decline in aggregate demand. The second is known as the real balance effect. If prices rise, the value (i.e. the purchasing power) of peoples money, whether held in cash or in their bank accounts and other savings accounts, will fall. People will be reluctant to reduce the real value of their money balances too much and will spend less on goods and services. Peoples attempts to protect the real value of their money balances thus cause aggregate demand to fall. The third reason people might switch away from spending concerns changes in interest rates. The higher price level causes an increase in the demand for money needed for undertaking transactions. If the supply of money does not change, this increase in the demand for money will cause interest rates to rise. (This process is examined in Chapter 13). These higher rates of interest will lead to a fall in investment by firms and to a fall in consumer spending that is financed by borrowing. Thus both the income effect and the substitution effect of a rise in the general price level will cause the aggregate demand for goods and services to fall. Shifts in the aggregate demand curve The aggregate demand curve can shift inwards or outwards, in exactly he same way as the demand curve for an individual good. In Figure 12.2 an increase in aggregate

demand is represented by a shift in the aggregate demand curve from AD 1 , to AD 2 . A decrease in aggregate demand is shown by a shift in the curve from AD 1 , to AD 0 .

Price level AD AD AD 0 GDP

Figure 12.2 Sifts in aggregate demand Pause for thought Give some examples of events that could shift the aggregate demand curve to the left A change in aggregate demand will occur If there is a change in any of its component parts consumption, investment, government expenditure on goods and services, or exports net of imports. Thus if the government decides to spend more, or if consumers spend more as a result or lower taxes, or if business confidence increases so that firms decide to invest more, the AD curve will shift to the right. A fall in any of these will cause the AD curve to shift to the left. 12.2 The aggregate supply curve How does the aggregate demand for goods and services vary with the price level? The aggregate supply curve shows the amount of goods and services that firms are willing to supply at any level of prices, other things remaining the same. The main variables that we hold constant when drawing the aggregate supply curve are wage rates, the prices of inputs other than labour, technology, and the labour force and the capital stock. Because these things obviously do change over time, by holding them constant we are analyzing the short-run aggregate supply curve. (Later in the chapter we will describe long-run aggregate supply curves). The aggregate supply curve upwards as shown in Figure 12.3. In other words, the higher the level of prices, the more will be produce. The reason is simple. Because we are holding wages and other input prices fixed, as the prices of firms products rise their profitability at each level of output will be higher than before. This will encourage firms to produce more. But what limits the increase in aggregate supply in response to an increase in prices? In other words, why is the aggregate supply curve not horizontal? There are two main reasons: Diminishing returns. With some factors of production fixed in supply, notably capital equipment, firms experience a diminishing marginal physical product from their other factors, and hence have an upward-sloping marginal cost curve. In microeconomic analysis the upward-sloping cost curve of firms explain why the supply curves of individual goods and services slope upwards. Here in macroeconomic we are adding the supply curves of all goods and services and thus the aggregate supply curve also upwards. Growing shortages of certain variable factors. As firms collectively produce more, even inputs that can be varied may increasingly become in short supply. Skilled labour may be harder to find, for example.
AS Price level

GDP

Figure 12.3 The aggregate sup curve Thus rising costs explain the upward-sloping aggregate supply curve. The more steeply costs rise as production increases, the less elastic will the aggregate supply curve be. It is likely that, as the level of GDP increases, the aggregate supply curve will tend to get steeper (as shown in Figure 12.3). That is, as GDP increases, the rate at which marginal costs rise will increases. Shifts in the aggregate supply curve The aggregate supply will shift if there is change in any of the variables that are held constant when we plot the curve. Several of these variables, notably technology, the labour force and the stock of capital, change only slowly in the short run normally shifting the curve gradually to the right. The wage rate (and other input prices) can change significantly in the short run, however, and are thus the main causes of shifts in the short-run supply curve. What effect will an increase in the average wage rate have on the aggregate supply curve? Wages account for around 70% of firms costs. If, therefore, wages increase, costs increase and profitability falls, and this reduces the amount that firms wish to produce at any level of prices. Thus the aggregate supply curve shifts to the left. A similar effect will occur of other input prices increase. A dramatic example of such a shift took place in 2000 when the price of oil tripled (see Box 7.1). 12.3 Equilibrium The determination of GDP and the price level Equilibrium in the macroeconomy occurs when aggregate demand and aggregate supply are equal. In Figure 12.4 this occurs at the price level P 1 , and at a level of GDP of GPD 1 . At any other combination of the price level and GDP the economy is out of equilibrium. When this occurs, changes will take place to move the economy towards equilibrium.
AS Price level P P AD 0 GDP GDP

Figure 12.4 The determination of the equilibrium level of prices and GDP To demonstrate this, consider what would happen if aggregate demand exceeded aggregate supply: for example, at P 2 in Figure 12.4. The resulting shortages throughout the economy would drive up prices. This would encourage firms to produce more: there would be a movement up along the AS curve. At the same time, the increase in prices would reduce the level of aggregate demand; that is, there would

also be a movement back up along the AD curve. The shortage would be eliminated when price had risen to P 1 . This explains how inflation occurs. An excess of aggregate demand over aggregate supply drives up prices. This excess can be caused by a rightward shift in AD, or a leftward shift in AS, or a combination of the two. When these shifts occur persistently enough to give persistent rises in prices, there is a problem of inflation. The faster the curves shift, the more rapidly prices rise and therefore the higher the rate of inflation. When inflation results from rightward shifts in aggregate demand, it is known as demand-pull inflation (or demand-side inflation). When it originates from leftward shifts in aggregate supply, it is known as cost-push inflation (or supply-side inflation). Let is examine each concept in turn. 12.4 Demand-pull inflation How changes in aggregate demand change the price level Demand-pull inflation is caused by rises in aggregate demand (i.e. persistent rightward shifts in he AD curve). These rises in aggregate demand may be due to rises in consumer demand, in the level of government expenditure, in investment by firms, or in foreign residents demand for the countrys exports, or any combination of these four events. Short-run effects So just what will happen if aggregate demand rises? Firms will respond to a rise in demand partly by raising prices and partly by increasing output. Just how much they raise prices depends on how much their costs rise as a result of increasing output. In other words, it will depend on the shape of the AS curve. The effect is illustrated in Figure 12.5. The rise in aggregate demand is illustrated by a rightward shift in the aggregate demand curve, from AD 1 to AD 2 . Prices rise from P 1 to P 2 , and output rises from GDP 1 to GDP 2 . The steeper the aggregate supply curve, the more prices will rise and the less output will increase. The aggregate supply curve tends to become steeper as the economy approaches the peak of the business cycle. In other words, the close actual output gets to potential output, and the less slack there is in the economy, the more will firms respond to a rise in demand by raising their prices.
AS Price level P P AD 0 GDP GDP

AD GDP

Figure 12.5 Demand-pull inflation Long-run effects Continuing shifts in aggregate demand. What we have illustrated so far is a single increase in demand (or a demand shock). This could be due, for example, to an increased level of government expenditure. The effects is to give a single rise in the price level. Although this causes inflation in the short run, once the effect has taken place inflation will fall back to zero. For inflation to persist there must be continuing

rightward shifts in the AD curve, and thus continuing rises in the price level. If inflation is to rise, these rightward shifts must get faster. Long-run aggregate supply. The increase in prices from P 1 to P 2 in Figure 12.5 is not the full long-run effect of a shift in the aggregate demand. The reason is that it will have changed peoples expectations about the future level of prices. As a result the short-run aggregate supply curve will start shifting upwards. Why? Remember we drew the AS curve on the assumption of fixed money wages. When the price level increased from P 1 to P 2 , the real wage will have fallen. As employees come to realize this they will try to negotiate an increase in money wages to compensate. Depending on how successful they are, money wages will rise. The result will be a rise in firms costs (their marginal cost curves will shift upwards) and thus they will charge a higher price at each level of output. Thus the AS curve will shift upwards and prices will increase further. This will then stimulate a further increase in wages and a further increase in prices and so on. The AS curve continues shifting upwards. How far money wages will rise, and thus how far the aggregate supply curve will shift, is a matter of contention. Let us take the case where the initial starting point is where GDP is at its fullemployment level (GDP F ). Actual GDP equals potential GDP. Now aggregate demand increases and, in Figure 12.6, we move along the short AS curve from a to b. As the initial level of GDP was full employment, it is clear that at the now higher GDP employees will be in a strong bargaining position to raise wages to compensate for the higher price level. So prices increase further. The aggregate demand curve shifts upwards as employees spend some of their additional earnings. In the long run, however, GDP cannot remain above its full-employment level so the ultimate outcome will be as shown by point c. The ultimate effect of the increase in aggregate demands is to raise prices, leaving GDP unaltered. We can draw a line through points a and c. These represent the long-run supply curve. It will be more or less vertical at the full-employment level of GDP. Over time it shifts to the rights as the potential or full-employment level of GDP grows due to technological change and to increases in the capital stock and the labour supply.
AS AS Price level c a 0 GDP b AD AD GDP AS

Figure 12.6 Long-run aggregate supply curve How long is the long run? There is considerable controversy over the process we have just described. In its simplest terms it is a controversy over how long it takes for the economy to move (in Figure 12.6) from point a to point c. The Keynesian view. One position on this issue might be summed up by Keynes statement that in the long run we are all dead. Thus those economists who are Keynesian argue that it takes some appreciable time a matter of years for the economy to settle at a new equilibrium following an increase in aggregate demand. You will recall that following an increase in demand, prices rise, output rises and

unemployment falls. Employees real wages fall. As they bargain, or negotiate, wage increases, the short-run aggregate supply curve shifts upwards. Keynesians argue that wages are frequently determined by a process of collective bargaining and, once agreed, will typically be set for a whole year, if not two or three. Even if they are not collectively bargained, wages and salaries change relatively infrequently. So too with prices: except in near-perfect markets such as commodity markets, or the markets for fruit and vegetables firms change their prices infrequently. They do not immediately raise them if there if there is an increase in demand for (or lover them when demand falls). Thus wages and prices are not flexible. Consequently the economy adjusts only slowly and the short run is a significant length of calendar time. The new classical view. At the other extreme is what is termed the new classical view. This rests upon two key assumption. First, prices and wage rates are flexible and markets, including the market for labour, clear very rapidly. This means there will be no disequilibrium unemployment. Second, people form their expectations about the future on a rational basis. That is, they use all available information to predict as well as they can the future level of prices and other economic variables. Thus if the government raises aggregate demand in an attempt to reduce unemployment, people will anticipate that this will lead to higher prices and wages, and that there will be no effect on output and employment. If their expectations of higher inflation are correct, this will thus fully absorb the increase in aggregate monetary demand, such that there will have been no increase in real aggregate demand at all. Firms will not produce any more output or employ any more people: after all, why should they? If they anticipate that people will spend 10% more money, but that prices will rise by 10% their volume of sales will remain the same. Output and employment will only rise, therefore, if people make an error in their predictions (i.e. if they underpredict the rate of inflation and interpret an increase in money spent as an increase in real demand). But they are as likely to overpredict the rate inflation, in which case output and employment will fall! The short run is therefore a very short length of calendar time. In effect we are always in the long run. The relationship between inflation and unemployment When demand-pull inflation occurs, what happens to unemployment? There are two stages to the inflationary process (see Figure 12.6). Initially prices rise and unemployment falls as GDP increases. This is during the move from point a to point b. Subsequently, as wages and other input costs rise, prices and unemployment both increase; this is during the move from point b to point c. 12.5 Cost-push inflation How increases in costs cause inflation Cost-push inflation is associated with leftward (upward shifts in the aggregate supply curve. Such shifts occur when costs of production rise independently of aggregate demand. When firms face a rise in costs, they respond partly by raising prices and passing the costs onto the consumer, and partly by cutting back on production. This is illustrated in Figure 12.7. There is a leftward shift in the aggregate supply curve: From AS 1 to AS 2 . This causes the price level to rise to P 2 and the level of output to fall to GDP 2 . Just how much firms raise prices and cut back on production depends on the shape of the aggregate demand curve. The less elastic the AD curve, the less sales fall as a result of any price rise, and hence the more will firms be able o pass on the rise in their costs to consumers as higher prices.

Note that the effect on output and employment is the opposite of demand-pull inflation. With demand-pull inflation, output and hence employment tend to rise in the short run. In the case of cost-push inflation, the effects is for firms to reduce output and employment. As with demand-pull inflation, we must distinguish between single shifts in the aggregate supply curve (known as supply shocks) and continuing shifts. If there is a single leftward shift in aggregate supply, there will be a single rise in the price level.
AS AS Price level P P

AD

GDP GDP

GDP

Figure 12.7 Cost-push inflation For example, if the government raises the excise duty on oil, there will be a single rise in oil prices and hence in industrys fuel costs. This will cause temporary inflation while the price rise is passed on through the economy. Once this has occurred, prices will stabilize at the new level and the rate of inflation will thus fall back to zero again. If cost-push inflation is to continue over a number of years, therefore, the aggregate supply curve must continually shift to the left. The rise in costs may originate from different sources. As a result, we can distinguish various types of cost-push inflation: Wage-push inflation. This is where trade unions push up wages independently of the demand for labour. Profit-push inflation. This occurs when firms use their monopoly power to make bigger profits by pushing up prices independently of consumer demand. Import-price-push inflation. This occurs where import prices rise independently of the level of aggregate demand: for example, when OPEC increased the price of oil in 2000. In all these cases, inflation occurs because one or more groups are exercising economic power. The problem is likely to get worse, therefore3, if the concentration of economic power increases steadily (e.g. if firms or unions get bigger and bigger, and more monopolistic) or if groups become more militant. These causes are likely to interact. Firms and unions may compete with each other for a larger share of national income. This can lead to wages and prices chasing each other upwards. Note, finally, that in a period of cost-push inflation, prices rise and so does unemployment, as GDP falls. The interaction of demand-pull an cost-push inflation Demand-pull and cost-push inflation can occur together, since wage and price rises can be caused both by increases in aggregate demand and by independent causes pushing up costs. Even when an inflationary process starts as either demand-pull or cost-push, it is often difficult to separate the two. An initial cost-push inflation may encourage the government to expand aggregate demand to offset rises in unemployment. Alternatively, an initial demand-pull inflation may strengthen the power of certain groups which then use this power to drive up costs.

A wage-price spiral may result. Employees demand higher and higher wages to cover higher and higher costs of living. Firms put up their prices to higher and higher levels to cover the higher and higher costs production. The government, in an attempt to avoid a recession, accommodates these price and wage rises by printing more and more money. Wage and price rises accelerate as these shifts get faster and faster. Inflation goes on rising. Box 12.1 Exploring Economics The Philips curve The relationship between inflation and unemployment was examined in a famous article by A.W. Philips back in 1958. He showed the statistical relationship between wage inflation and unemployment in the UK from 1861 to 1957. With wage inflation (W) on the vertical axis and the unemployment rate (U) on the horizontal axis, a scatter of points was obtained. Each point represented the observation for a particular year. The curve that best fitted the scatter has become known as the Philips curve. It is illustrated in Figure A and shows an inverse relationship between inflation and unemployment.
9 8 7 W (%) 6 5 4 3 2 1 1 2 3 U (%) 4 5 6

Figure A The Philips curve Given that wage increases over the period were approximately 2% above price increases (made possible because of increases in labour productivity), a similarshaped, but lower curve could be plotted showing the relationship between price inflation and unemployment. The curve has often been used to illustrate the effects of changes in aggregate demand. When aggregate demand rose (relative to potential output), inflation rose and unemployment fell: there was a movement upward along the curve. When aggregate demand fell, there was a movement downward along the curve. The Philips curve was bowed in to the origin. The usual explanation for this is that as aggregate expanded, at first there would be plenty of surplus labour, which could be employed to meet the extra demand without the need to raise wage rates very much. But as labour became increasingly scarce, and the position of trade unions would be increasingly higher wage rates to obtain the labour they required, and the position of trade unions would be increasingly strengthened. The position of the Philips curve depended on non-demand factors causing inflation and unemployment: frictional and structural unemployment; and cost-push inflation. If any of these non-demand factors changed so as to raise inflation or unemployment, the curve would shift suggested that no much simple relationship exists beyond the short run.

From about 1966 the Philips curve relationship seemed to break down. Australia and the UK, along with many other countries in the Western world, began to experience growing unemployment and higher rates of inflation as well. Exactly what is the relationship between inflation and unemployment is a matter of some controversy. The analysis in Section 12.4 shows, however, that it is not as simple as suggested by the Philips curve. Box 12.2 Exploring Economic Deflation A problem of falling prices For the past 50 years inflation has been seen as a potentially serious problem. This concern peaked in the 1970s when inflation was at historically high levels in most countries. Average inflation for the decade was, for example, 9.8% in Australia and 13.0% in the UK (see Table 10.1). inflation rates in most advanced economies have fallen considerably and in the early 2000s concern was being expressed about deflation. Deflation is a continuing fall in the general price level. It is precisely the opposite of inflation. Deflation had been occurring in Japan since 1999. Table A Annual % changes in the price level: Japan 1999-00 -0.7 2000-01 -0.5 2001-02 -0.3 2002-03 -1.2 For a while it seemed as if, among major economies, deflation would be confined to Japan. In 2003, however, signs were emerging that deflation might occur in the near future in other economies, notably the USA, France and Germany. There are three main threats posed by deflation. First, households and firms that are carrying debt find that the burden of their debt increases as prices fall. If you owe $10 000 and the price level falls by 2%, the amount you owe in real terms (in todays purchasing power) goes up to $10 200. This can lead to a vicious circle. Indebted firms find it increasingly difficult to make debt repayments and are forced to reduce costs, and to reduce employment. Similarly households who have debts in the form of mortgages, personal loans and outstanding credit-card balances have to reduce consumption. There is thus a reduction in spending across the economy, which will push prices even lower. Second, this first effect will be reinforced by peoples expectations of future prices. If you are considering buying a new washing machine and prices this year fell by 3% you might postpone your purchase in the expectation that prices would fall next year as well. The more people react in this way, the greater the reduction in aggregate demand and the greater the fall in prices. Third, deflation brings with it very low nominal interest rates. The problem with this is that it becomes impossible to use reductions in interest rates to stimulate the economy. This is because interest rates cannot be negative as nobody would have any incentive to lend at that rate. The interest rate thus has an absolute floor of zero. In Japan the interest rate offered by banks on deposit accounts in 2003 was 0101%. (So to get an annual interest income of $1000 a year you would need a deposit of $10 million) AS we shall see in Chapter 13, the main instrument in monetary policy is changes to interest rates. In a time of deflation this instrument cannot be used.

The way to avoid these problems is to move aggressively to prevent prices falling in the first place. This was the path adopted by the Federal Reserve Bank in the USA where, by mid-2003, official interest rates had fallen to 1%. Fiscal policy (that is, increasing government expenditure and / or reducing taxes) can also be used to stimulate the economy a course also followed in the USA in 2002/03. Once deflation occurs, the experience of Japan has shown that large fiscal explanations cannot be relied upon to induce growth in output (see Box 14.1). SUMMARY 1. The price level of output in the economy are jointly determined by aggregate demand and aggregate supply. 2. There are four components of aggregate demand: consumer expenditure, private investment, government expenditure on goods and services, and exports net of imports. 3. The aggregate demand curve shows how many goods and services will be demanded at each level of prices. Aggregate demand decreases as the price level increases. There are three main reasons for this. First, the higher price level makes exports less competitive overseas and increase imports. Thus exports less imports decline. Second, the real value of peoples money balances fall. They lose wealth and demand fewer goods and services. Third, the higher price level causes interest rates to rise and thus investment falls. (This is explained in Chapter 13.) 4. The aggregate demand curve shifts if any of its four component parts changes independently of a change in the price level. 5. The aggregate supply curve shows how many goods and services will be supplied at each price level. It is drawn on the assumption that money wages are fixed. It slopes upwards. To induce firms to supply more, the price level must rise. The reason for this is that as output increases firms face increasing marginal costs due to the law of diminishing marginal returns. In other words, the aggregate supply curve has a similar shape to the supply curves of individual firms. 6. The aggregate supply curve shifts if any of the variables held constant when the curve is drawn change. These are money wages, technology and the stock of capital. 7. Macroeconomic equilibrium occurs when aggregate demand and supply are equal. 8. Demand-pull inflation occurs as a result of an increase in aggregate demand. This causes prices and GDP to increase: unemployment falls due to the increase in GDP. The increase in the price level causes real wages to fall. Employees negotiate for higher wages to restore their real wages. As wages rise, the aggregate supply curve shifts upwards and prices rise further. However, the shift in the aggregate supply curve causes GDP to fall back towards its original level, and thus unemployment to increase towards its original level. 9. The line relating supply to the price level in the long run is called the long-run aggregate supply curve. It is more or les vertical at the full-employment level of GDP. 10. In the short run, changes in aggregate demand cause increases in GDP. There is some dispute among economists as to how long it takes for increases in wages (and thus upward shifts in the aggregate supply curve) to eliminate the increase in GDP. Keynesian economists think it is a matter of years. New classical economists think wage and price adjustment will take place very quickly.

11. Cost-push inflation occurs when there are increases in the costs of production independent of rises in aggregate demand. This might be due to an increase in import prices or its employee attempts to increase wages. 12. In practice, demand-pull and cost-push inflations will often interact and make it difficult to identify the initial cause.