What is Demand-Pull inflation?

As its name suggests, demand-pull inflation is an economic phenomenon wherein the demand for goods surpasses supply. Typically, when an increasing demand influences the range of products available, their costs will most likely increase.

Consequently, when the supply level cannot cope with an uprising demand, prices for products and services increase. Governments adopt measures like increasing taxes, reducing government spending, or raising interest rates to tackle this situation.

In an economy, demand-pull inflation occurs when the demand for products or services increases faster than supply. When there is a sudden escalation in demand for the available products in a market, their values get increased.

Although a short-term inconsistency in demand and supply may not cause too much effect, interminable high demand may affect a country's economy by increasing the costs of items. In demand-pull inflation, as demand outpaces supply, manufacturers compulsively have to increase the selling prices of their goods.

Most economies of the world experience demand-pull inflation owing to some monetary and real factors. Some noteworthy causes that trigger this economic phenomenon are as follows:

• Robust Economy: Suppose a country's economy is prosperous and on the right track with scanty unemployment, a high level of productivity and substantial national income. This can make the consumers confident, and they tend to spend more money and take more loans and credit cards. Subsequently, this may lead to a gradual increase in demand, which signifies higher prices, and eventually cause demand-pull inflation.
• Rising Rate of Inflation: When there is an inflationary situation, and the rate of inflation increases, the demand for products and services also starts to increase as individuals want to save money by purchasing goods when they are affordable. For instance, if a family plans to go for a home improvement project three years later, but the inflation rate has increased, they may go for the improvement project as soon as possible. This may increase demand for home improvement projects in the short term, triggering inflation pressure.
• Technological Innovations: With new and innovative technologies, the demand for such products and services increases. For instance, even if a brand new cellphone is launched with a high price tag, it will fetch a considerable demand as people like to invest more in technologies suited to their lifestyles. Previously, when cell phones were new to the market, their manufacturers were few, and each product dominated the market until a rival product was introduced. The demand often outpaced supply, and while buyers paid more to acquire them then, they will not be willing to pay the same now. This means the increased demand inflated the price for a certain period.
• Rapid Increase in Supply of Money: Monitoring and influencing the money supply in an economy is one of the primary activities of the Reserve Bank of India (RBI). The government printed and supplied more currency when the national debt hit the roof. With more and more money supply, it reduces interest rates, which puts more cash in the hands of common people, thereby encouraging spending. The fast increase in liquidity brings higher demand for products and services. Demand-pull inflation is triggered when businesses cannot increase their supply to balance the demand.
• Tax Reduction: Although, in reality, the taxes increase in due course of time, there are few occasions when governments lessen taxes to put more money in the hands of consumers to spend and encourage economic growth. This satisfies people since they have adequate funds to fulfil their personal and financial needs. However, if the production rate does not increase at a parallel rate, the surplus cash in hand can lead to inflation.
• Imposition of Indirect Taxes: Taxes refer to the principal source of revenue for the Government of India. Earlier, the government imposes indirect taxes, such as VAT, excise duty, customs duty, stamp duty, etc., on businesses. As these indirect taxes increase the total cost for manufacturers or sellers, they tend to increase their product prices to maintain their profitability. Today, the GST has replaced these indirect taxes.
• Non-economic Reasons: There are a few non-economic aspects that may lead to demand-pull inflation in the economy of a country. For instance, the crops get destroyed in the event of a flood or earthquake. This diminishes agricultural goods supply, increasing prices considerably and causing demand-pull inflation. Investing in gold, real estate, mutual funds, stocks, etc., is the best way to cope with such circumstances.
• Inflation Expectations: Inflation expectations signify predicting an increase in prices from the viewpoint of customers, businesses, investors, and analysts. In India, as per the reports, inflation expectations were reduced from 11% to 10.80% in November 2022.

When individuals expect inflation to escalate in the future, they may start purchasing more things to avoid paying more for the same product later. Doing so causes a shortage in supply and thus leads to demand-pull inflation.

1. Rise in Fuel Prices

2. Covid-19 Pandemic Demand

3. Global Events

Another notable example that triggers demand-pull inflation is global events. For instance, the Russia-Ukraine war in 2022 increased the price of essential resources such as fuel and gas since their supply was scanty. 

As a result, it caused an escalation in the prices of goods and raw materials. Consequently, with the increased costs, the consumers and business sectors had to pay more than usual.

From the above thoughts, one can understand that demand-pull inflation is a price rise caused when consumers' interest or total demand rises above productive capacity or total supply. Therefore, it is important to know the causes of demand-pull inflation to detect and tackle the situation.