“Demand-pull inflation is result of increase in demand in economy with supply remaining stagnant.”
Imagine this situation, in an army cantonment near Shimla, 5 officer wives used to purchase 1 kg apple from a farmer who is selling his own farm best apples.
Farmer is selling = 5kg everyday.
Wives are purchasing = 5kg everyday, and 1kg/each.
After new pay commission enforcement, officers salary just doubled. Now wives are planning to rearrange their expenditure on vegetables, and are willing to purchase more apple from farmer who comes and sell the best apple in cantonment.
Until unless farmer apple produce won’t double, & wives do not plan to buy apple from outside the cantonment, apple price is going to spike ultimately. Let’s see how.
1 officer wife offers 10 rs more per 1kg.
Another officer wife offers 15 rs more.
But there is limitation on their expenditure. No sane wife will put in whole salary to buy apples, just to win the competition. Rather she will start looking for other options, if it becomes out of her reach to buy apples from same farmer.
Evaluate about example:
1) Apple supply remain same
2) Demand of apple increase
3) More salary to officers after new pay commission
4) More expenditure by wives.
This is the example where only 5 person are demanding, there can be situation where more officer wives started demanding apple from same farmer, which will also contribute to inflation in apple price.
Reason of Demand-Pull inflation:
A) Increase in population (Natural Phenomena)
B) Increase in money-supply creating sudden increase in Purchasing power (Ultimately leaving behind inflation)
C) Consumerism, in which consumer buy or stock more than needed.
Demand-Pull inflation is scenario in which extra money doesn’t get soaked in economy, that is no increase in economic activity, Hence Currency value depreciate (Less goods more money).
Refer to this example for more illustration.