Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Types of Inflation

Types of Inflation

So, you usually walk into the store with $8 and pick up some Kool-Aid. However, this time, you pick up some Kool-Aid, walk to the counter, and you're told you're a dollar short. How? Inflation! That's how. There are different types of inflation, but inflation basically raises the general price level in an economy. When this happens, we realize that our money is just not worth as much as it used to be. What's even worse is that our incomes can stay the same while our money loses its value. This puts us in a tight spot and makes us consume less, unwillingly! Anyway, let's just get into the types of inflation so we understand what makes our money lose value. Read on!

Types of inflation and deflation

We'll discuss the types of inflation and deflation, but first, let's briefly introduce what inflation is. Inflation is said to occur when the general price level in an economy increases. So, if $100 was enough to go grocery shopping before, it would become inadequate due to inflation. In other words, it reduces the purchasing power of money.

Inflation is the increase in the general price level in an economy.

You should know that inflation does not mean that the price of everything in the economy has gone up. In some cases, the prices of some items remain unchanged. However, generally, things become more expensive, and we find ourselves struggling to buy the same things we used to buy with the same amount of money.

You must be wondering what deflation is since you saw it in the heading. Well, deflation is the opposite of inflation. It is said to have occurred when there is a drop in the general price level in an economy. When this happens, your money can buy more things since its purchasing power has increased.

Deflation is the decrease in the general price level in an economy.

We just defined deflation, but we're really here for the types of inflation, so what are the two types of inflation? They are demand-pull inflation and cost-push inflation. We'll discuss these in much detail later.

Different types of inflation

Strictly speaking, the different types of inflation are demand-pull inflation and cost-push inflation. Any inflation you encounter comes from either of these two types.

The different types of inflation are demand-pull inflation and cost-push inflation.

Let's briefly explain what each type of inflation is. As the name suggests, demand-pull inflation is inflation that results from excess demand that cannot be matched by production. So, demand is virtually pulling the prices up.

Demand-pull inflation is inflation that results from excess demand that cannot be matched by production.

On the other hand, cost-push inflation is inflation that results from an increase in production costs. As production costs increase, producers are able to make less output. This drop in supply results in an increase in prices.

Cost-push inflation is inflation that results from an increase in production costs.

When supply goes down, prices go up.

Demand-pull inflation

Now, let's go into the details of demand-pull inflation. This one happens when all resources or factors of production are employed in the economy, yet, demand still exceeds what the economy can produce. It happens as people have a lot of money to spend, but they just cannot get enough goods to buy. So, the producers decide, well, if everybody has a lot of money, then let's raise the prices, and those who really need the products will buy them.

Demand-pull inflation is inflation that results from excess demand that cannot be matched by production.

Demand-pull inflation happens when the central bank issues too much money. From this point on, there is a lot of money to spend, and businesses are unable to keep up with the demand. So, they increase prices. You'll not be asking for more products if you run out of money, right? Figure 1 shows demand-pull inflation.

Types of inflation Demand pull inflation StudySmarterFig. 1 - Demand-pull Inflation

The graph shows output (as measured by real GDP) on the horizontal axis and aggregate price level on the vertical axis. Notice how the aggregate demand (AD) curve shifts to the right (from AD1 to AD2), resulting in an increase in the aggregate price level from P1 to P2.

Cost-push inflation

Cost-push inflation is inflation that is triggered by high costs. This description puts it too simply, so let's go into some detail. This type of inflation is a result of increases in production costs. If the cost per unit of output increases and producers need to continue making profits, they will increase the prices of the output accordingly.

Cost-push inflation is inflation that results from an increase in per-unit production costs.

Economists refer to this cost as the per-unit production cost. It is calculated as the average cost of a given output level.

\(\hbox{Per-unit production cost}=\frac{\hbox{Total input cost}}{\hbox{Quantity of output}}\)

If the previous per-unit production cost is less than the current per-unit production cost, then cost-push inflation is triggered, and the general price level goes up. Figure 2 shows cost-push inflation.

Types of inflation Cost push inflation StudySmarterFig. 2 - Cost-push Inflation

The cost-push inflation graph also shows output or real GDP on the horizontal axis and aggregate price level on the vertical axis. In this case, take note of how the short-run aggregate supply (SRAS) curve shifts to the left (from SRAS1 to SRAS2), resulting in an increase in the aggregate price level from P1 to P2.

Other Types of Inflation

Built-in inflation is not necessarily a type of inflation since it has to come from either demand-pull inflation or cost-pull inflation. But it's interesting and important to know, so let's discuss it.

Other Types of Inflation: Built-in Inflation

This is best explained with an example. So, look here.

You earn $500 weekly, and this has been enough to buy the things you need to buy all the time. Suddenly, prices increase, and this $500 stops being enough. Therefore, you expect your employer to increase your salary, so you can return to normal, affording what you've been affording all this while.

The above scenario describes built-in inflation. It is inflation that results from workers' demand for wages that match the increase in the prices of goods and services. But things can spiral out of control because wages are the cost of a factor of production (labor), and increasing wages means that the per-unit cost of production has increased. Which will then result in cost-push inflation.

Built-in inflation is inflation that results from workers' demand for wages that match the increase in the prices of goods and services.

You should know, however, that built-in inflation does not pop up out of nowhere. Rather, it emerges after demand-pull inflation or cost-push inflation has taken place. Interesting, isn't it?

Hyperinflation is another interesting one, it's inflation, but inflation is so fast that the prices go up before the previous increase has the chance to settle in. Let's discuss it.

Other Types of Inflation: Hyperinflation

Hyperinflation simply refers to extremely fast inflation. Here, inflation happens so fast that it keeps everybody on edge, expecting the next rapid increase.

Hyperinflation refers to extremely fast inflation.

When there is hyperinflation, business is significantly disrupted because everyone wants to wait and see what happens. For instance, businesses begin to hold on to their output, whereas consumers begin to hoard products in anticipation of another rapid inflation. In such a situation, money becomes almost worthless since nobody even wants to keep it or use it for transactions.

Types of inflation and Example

Here, let's look at an example for each type of inflation. First, consider this example of demand-pull inflation.

There is a pandemic, which causes many businesses to close down while many workers are laid off. However, the laid-off workers need to get by, so the government issues stimulus checks to certain citizens, making sure they can buy necessities. However, the businesses have closed down, so it's not like new products are being made, and the availability of money means that consumers are demanding more products than producers have available.

In the above example, we can see that the government has given out money, but production is down anyway, so producers will increase the prices of the few products available due to the excess demand.

Now, let's look at this example of cost-push inflation.

Crude oil is the main resource required for many fuels consumers buy. Crude oil is also one of the most popular commodities traded internationally. Now, let's say the relationship between an oil-producing country and an oil-buying country turns bad. The oil-buying country now has to buy crude oil at a higher price. What this causes is an increase in the prices of the final fuel products.

In the above example, crude oil is the resource that has caused the increase in the per-unit production cost of fuels. This results in cost-push inflation.

Now, let's look at the inflation rate of the USA from 2012 to 2021 to give us a picture of real-life inflation.

Take a look at Figure 3 below.

Types of Inflation USA Inflation Rate 2019 2022Fig. 3 - USA Inflation Rate 2019-2022. Source: Bureau of Labor Statistics1

Figure 3 above illustrates the fluctuations in the inflation rate of the USA from 2019 to 2022. It can be seen that the inflation rate fluctuated between 2.2 and 6 percent. The significant rise in inflation rate after 2019 is due to the significant decline in production and household spending during the Covid-19 pandemic. Essentially, this is a demand-pull inflation since there is high demand post-pandemic which suppliers are struggling to meet, since they did not produce enough during the pandemic.

Read our articles on Inflation and the Market Basket to learn more.

Types of inflation - Key takeaways

  • Inflation is the increase in the general price level in an economy.
  • The different types of inflation are demand-pull inflation and cost-push inflation.
  • Demand-pull inflation is inflation that results from excess demand that cannot be matched by production.
  • Cost-push inflation is inflation that results from an increase in per-unit production costs.
  • Built-in inflation is inflation that results from workers' demand for wages that match the increase in the prices of goods and services.

References

  1. Bureau of Labor Statistics, CPI for All Urban Consumers, https://data.bls.gov/timeseries/CUUR0000SA0L1E?output_view=pct_12mths

Frequently Asked Questions about Types of Inflation

The 3 types of inflation are demand-pull inflation, cost-push inflation, and built-in inflation.

The types of inflation are demand-pull inflation and cost-push inflation. Demand-pull inflation is caused by an increase in demand over the production capacity of producers. Cost-push inflation is caused by an increase in the per-unit cost of production.

An example of cost-push inflation is an increase in crude oil prices, which causes fuel prices to go up.

The name, "cost-push inflation" is due to the push effect the input costs have on the price level.

Demand-pull inflation is the more common type of inflation, as producers often increase prices when they realize there is a high demand for their products.

Final Types of Inflation Quiz

Question

What is inflation?

Show answer

Answer

Inflation is the increase in the general price level in an economy.

Show question

Question

What is deflation?

Show answer

Answer

Deflation is the decrease in the general price level in an economy.

Show question

Question

Inflation and deflation can occur at the same time.

Show answer

Answer

False

Show question

Question

Demand-push inflation is a type of inflation.

Show answer

Answer

False

Show question

Question

Cost-pull inflation is not a type of inflation.

Show answer

Answer

True

Show question

Question

What is hyperinflation?

Show answer

Answer

Hyperinflation refers to extremely fast inflation.

Show question

Question

Define demand-pull inflation.

Show answer

Answer

Demand-pull inflation is inflation that results from excess demand that cannot be matched by production.

Show question

Question

Define cost-push inflation.

Show answer

Answer

Cost-push inflation is inflation that results from an increase in per-unit production costs.

Show question

Question

Built-in inflation usually happens on its own.

Show answer

Answer

False

Show question

Question

What is built-in inflation?

Show answer

Answer

Built-in inflation is inflation that results from workers' demand for wages that match the increase in the prices of goods and services.

Show question

Question

Demand-pull inflation results from an increase in demand over what producers can supply.

Show answer

Answer

True

Show question

Question

Cost-push inflation results from producers having too much cheap input.

Show answer

Answer

False

Show question

Question

If the central bank issues too much money, demand-pull inflation can occur.

Show answer

Answer

True

Show question

Question

If workers demand higher wages due to inflation, and they get it, then inflation is fixed.

Show answer

Answer

False

Show question

Question

The aggregate demand curve shifts to the right in demand-pull inflation.

Show answer

Answer

True

Show question

60%

of the users don't pass the Types of Inflation quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.