In the context of demand-pull and cost-push inflation, cost-push inflation may be caused by which of the following?

• A. A reduction in the money supply that lowers interest rates and shifts aggregate demand right
• B. An economy-wide increase in input costs such as wages or energy prices that shifts short-run aggregate supply left
• C. A decrease in government spending that shifts aggregate demand left
• D. An increase in consumer confidence that raises consumption spending and shifts aggregate demand right

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the difference between demand-pull and cost-push inflation. Demand-pull inflation occurs when aggregate demand increases, pushing prices up, while cost-push inflation happens when the costs of production increase, reducing aggregate supply and raising prices.
2. Step 2: Identify the factors that shift aggregate demand (AD) and aggregate supply (AS). An increase in consumer confidence or government spending shifts AD to the right, while a decrease in these shifts AD to the left. Changes in input costs like wages or energy affect short-run aggregate supply (SRAS).
3. Step 3: Analyze each option to see which one affects SRAS rather than AD. A reduction in money supply or a decrease in government spending affects AD, not AS. An increase in input costs raises production costs, shifting SRAS to the left.
4. Step 4: Recognize that cost-push inflation is caused by a leftward shift in SRAS due to higher input costs, which reduces output and increases the price level.
5. Step 5: Conclude that the correct cause of cost-push inflation is an economy-wide increase in input costs such as wages or energy prices that shifts short-run aggregate supply left.