Demand-Pull Versus Cost-Push Inflation

Inflation is just a rising price level, but two very different stories can produce it, and the model tells them apart by which curve moved. Demand-pull inflation happens when aggregate demand shifts right: more spending from consumers, businesses, government, or foreigners pulls the economy along the short-run aggregate supply curve to a higher price level and higher real output. This is the classic 'too much money chasing too few goods' story, and it fits because demand is the thing that grew.

Cost-push inflation happens on the supply side. Something raises the cost of producing goods, like a spike in oil prices, wages, or raw materials, and that shifts short-run aggregate supply left. Firms now produce less at every price level, so the price level rises, but real output falls. Same direction of price change, opposite direction of output change. That is the fingerprint that lets you diagnose which curve actually moved just by watching what happens to GDP alongside prices.

This distinction matters because the fix differs. Demand-pull inflation, paired with rising output, suggests the economy may be overheating past full employment, which argues for contractionary policy to cool demand without crushing output too hard. Cost-push inflation is uglier: prices rise while output and employment are already falling, a combination called stagflation. Policymakers face a tradeoff, since fighting inflation with contractionary policy would shrink output further, while fighting the output drop with expansionary policy would push prices even higher. Knowing which shock hit tells you which pain you are choosing.