(a) What is demand- pull inflation? (b) Why is price control not suitable in checking this type of inflation?

Answer Details

(a) Demand-pull inflation. Demand-pull inflation is a persistent rise in the general price level caused by aggregate (total) demand for goods and services growing faster than the economy's ability to supply them. Because "too much money chases too few goods," the excess demand pulls prices up. It arises from factors such as rising government spending, increased money supply, higher consumer spending, or export booms while output is near full capacity.

(b) Why price control is not suitable for checking demand-pull inflation.

• It attacks the symptom, not the cause. The root problem is excess demand relative to supply; fixing maximum prices does nothing to reduce that excess demand.
• It creates shortages. A price ceiling set below the equilibrium price leaves quantity demanded greater than quantity supplied, so goods disappear from the shelves.
• It breeds a black market. Scarce goods are diverted and sold illegally at prices even higher than before, so the true cost to consumers rises.
• It discourages production. Controlled prices reduce producers' profit incentive, cutting supply further and worsening the underlying imbalance.
• It is difficult and costly to enforce across many goods, leading to hoarding, rationing, and corruption.

The appropriate remedies instead reduce aggregate demand: contractionary monetary policy (raising interest rates, reducing the money supply) and contractionary fiscal policy (cutting government spending or raising taxes).

Examination takeaway. A correct policy must address the cause of the inflation; since demand-pull inflation comes from excess demand, only demand-reducing (deflationary) policies are appropriate, not price fixing.