How It Happens
According to Keynesian theory, the more firms will employ people, the more people that are employed, the higher aggregate demand (AD) will become. This greater demand will make firms employ more people in order to output more. Due to capacity constraints, this increase in output will eventually become so small that the price of the good will rise. At first, unemployment will go down, shifting AD1 to AD2, which increases demand (noted as "Y") by (Y2 - Y1). This increase in demand means more workers are needed, and then AD will be shifted from AD2 to AD3, but this time much less is produced than in the previous shift, but the price level has risen from P2 to P3, a much higher increase in price than in the previous shift. This increase in price is called inflation.
Demand-pull inflation is in contrast with cost-push inflation, when price and wage increases are being transmitted from one sector to another. However, these can be considered as different aspects of an overall inflationary process: demand-pull inflation explains how price inflation starts, and cost-push inflation demonstrates why inflation once begun is so difficult to stop.
Read more about this topic: Demand-pull Inflation
Famous quotes containing the words how and/or happens:
“It may be tempting to focus on the fact that, even among those who support equality, men’s involvement as fathers remains a far distance from what most women want and most children need. Yet it is also important to acknowledge how far and how fast many men have moved towards a pattern that not long ago virtually all men considered anathema.”
—Katherine Gerson (20th century)
“Oh, I love Proust. We all learned from him how to go back in time. The difference is that Proust stayed in his room, and he observed himself. He was Proust lying in his bed looking at Proust at the window who was looking at Proust in bed. In our generation’s case, we are always in the middle. We are never on the outside. Whatever happens, happens to us.”
—Elie Wiesel (b. 1928)