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Inflation is a sustained rise in the general price level. Demand-pull inflation occurs when aggregate demand expands faster than potential output, pulling prices up. Cost-push (supply-shock) inflation occurs when input costs rise (e.g., oil price spikes), shifting aggregate supply left and raising prices while reducing output. Moderate inflation is consistent with healthy growth; hyperinflation destroys economic coordination by eroding the informational content of prices. Unanticipated inflation redistributes wealth from creditors to debtors.
Study historical episodes — the 1970s US stagflation (cost-push), the 2021–2023 post-COVID inflation (mixed demand and supply), and the Weimar hyperinflation — and classify each using demand-pull vs. cost-push framing.
Inflation means the general price level is rising over time — not that one price went up, but that the average across the whole economy is climbing. Your prerequisite on CPI measurement showed how to track this with a price index; now we examine why it happens and what it does. The two root causes give rise to two types of inflation, and they have very different policy implications.
Demand-pull inflation arises from the spending side of the economy. When aggregate demand expands faster than potential output — because consumers are spending freely, the government is running large deficits, or easy monetary policy has lowered borrowing costs — firms face excess demand for their goods. They respond by raising prices. In the AS-AD framework you will study next, this corresponds to demand pushing the economy up along a short-run aggregate supply curve: output rises above potential and the price level rises. Think of too much money chasing too few goods. Post-COVID inflation in 2021–2022 had a significant demand-pull component: massive fiscal transfers and pent-up consumer demand outpaced supply capacity.
Cost-push inflation arises from the supply side. When input costs rise — oil prices, wages, raw materials, supply-chain disruptions — firms must charge more to maintain profit margins, even if demand has not changed. In AS-AD terms, the aggregate supply curve shifts left: the price level rises and output falls simultaneously. This combination — higher prices with lower output — is called stagflation, and it is the signature failure of cost-push episodes like the 1970s OPEC shocks. Demand-management tools (raising interest rates, cutting spending) can fight demand-pull inflation without sacrificing output, but they cannot fix a supply shock without also reducing output further, which is why stagflation was so difficult to address.
The distinction between anticipated and unanticipated inflation is as important as the demand-pull/cost-push split. When households, firms, and lenders correctly anticipate inflation, they adjust: workers demand higher nominal wages, firms raise prices on schedule, and lenders charge higher nominal interest rates to preserve real returns. In this case, inflation is mostly a "nuisance tax" — it erodes the purchasing power of cash holdings and creates menu costs — but it does not dramatically distort real economic outcomes. Unanticipated inflation, however, redistributes wealth: borrowers repay loans with dollars worth less than lenders expected, and anyone holding fixed nominal contracts (pensions, long-term bonds, fixed-rate mortgages) loses real value. This is why hyperinflation — extreme, rapid, and inherently unanticipatable — destroys economic coordination. When prices double every few weeks (Weimar Germany, Zimbabwe, Venezuela), firms cannot plan, savings are wiped out, and money itself stops functioning as a reliable store of value or unit of account.
Finally, keep the level-vs.-rate distinction sharp. A 3% inflation rate does not mean prices are at "level 3" — it means the price level is rising 3% per year. If inflation falls from 5% to 3%, prices are still rising, just more slowly. Disinflation (falling inflation rate) is not deflation (falling price level). Deflation — prices actually declining — is also dangerous, because it incentivizes consumers to delay purchases (waiting for lower prices) and increases the real burden of existing debt, which can trigger debt-deflation spirals like those seen in the Great Depression.