distinguish between demand-pull and cost-push inflation.

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Ans.) a.) Inflation may be defined as a persistent increase in the average price level of the economy. The causes of inflation can be primarily divided into two types , ‘Demand-pull’ and ‘Cost-push’ inflation. Though inflation does not distinctively relate to a particular type, and both the types occur in cycles known as ‘inflationary spiral’, their differences are important to ascertain which policies are to be implemented to mitigate inflation. Demand-pull inflation is the type of inflation which is the result of an increase in aggregate demand. Aggregate demand increases, due to changes in any of the components. For example, if national incomes rise, consumption increases; or if foreign incomes increase, the economy’s exports are more in demand. There are two cases of aggregate demand, one is when the economy is approaching full employment (Shown by Fig.1) and the other, when the economy is at the full employment level (Shown by Fig.2). When aggregate demand increases, firms try to increase output to meet the rising demand. In the first case, when aggregate demand rises, it results with an increase in average price level (From P1 to P2, Fig.1) and an increase in real output, because when the economy is approaching full employment, there is spare capacity to meet the demand. However, when the economy is operating at full employment (Y=FE) level and the economy’s productive potential has reached it’s peak, the only way to curb the surplus demand, is by raising the average price level (From P1 to P2, Fig.2). Any increase in aggregate demand further on, would be purely inflationary. Fig.1. Demand-pull inflation while Fig.2. Demand-pull inflation at full approaching full employment. employment. On the other
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