Q:

What is demand-pull theory?

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Quick Answer

In the Keynesian economics model, demand-pull theory posits that when demand for products and services goes beyond existing supplies, the result is inflation. According to demand-pull inflation, when there is too much money and too few goods, the inevitable result is that prices go up.

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Full Answer

The logical step when demand increases is to increase supply. However, sometimes there is a supply constraint, or some reason that supply does not meet the demand, and this is what brings on inflation.

Several situations exacerbate this issue. In a growing economy, consumers feel confidence in the government and increase their spending instead of saving, and this gradually increases prices. Another trigger is when people expect inflation and as a result increase their spending before prices go up. A third cause is when the fiscal policy of the government causes increased spending in particular sectors, such as increased military spending raising prices on military supplies or lower taxes on mortgages causing a boom in housing purchases. Sometimes the demand for special brands of cutting-edge technological gadgets causes a spike in prices.

After the 2008 financial crisis, demand-pull inflation caused a rise in gold prices that resulted in gold reaching a record high price per ounce in 2011. Another commodity with an inflated price after the crisis was oil.

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