Economists believe that in an economy, actual inflationary process contains some elements of both demand pull inflation and cost push inflation. They state that both the forces operate simultaneously and independently in an inflationary process. Thus, mixed inflation is when change in price level is a result of change in both aggregate demand and aggregate supply functions.
But, economists also argue that both demand pull and cost push inflations do not occur simultaneously. The inflationary process may begin with either excess of demand or an increase in costs of production.
When inflation begins with excess demand with no cost push forces, prices rise and consequently leads to rise in wage rates (rise in cost of production). Here, wages do not increases because of cost push inflation but because of rise in prices. This is because, when the price of commodities increase, individuals would want a raise in their income in order to keep up with the economy. Thus, mixed inflation takes place.
On the other hand, when inflationary process starts with cost push inflation, prices rise but output declines. Subsequently, problem of unemployment occurs in the economy. In order to avoid economic recession, government adopts expansionary monetary and fiscal policies. Increase in government’s expenditures give rise to employment opportunities which further increases income level and purchasing power of people. As a result, demand for commodities increase, causing a price rise and thus, leading to demand pull inflation.
The diagram below clearly explains the concept of mix inflation:
As seen in the diagram, forces that affect aggregate demand and aggregate supply simultaneously affect each other. The initial point of equilibrium is E0 where, aggregate demand curve ADo intersects aggregate supply curve AS0, and the equilibrium price is P0 and output is Y0.
Suppose, wage rates rise due to the activities of the trade union. Rise in wage shifts the AS curve to AS1 and the new equilibrium point is E1. At this point, the higher price level is at P1 and the reduced level of output is at Y1. This is cost push inflation.
As the government takes measures to increase employment level in the economy, income level rises and causes a shift in the demand curve from AD0 to AD1. The new equilibrium point is E2 where the rise in price is P2. This is demand pull inflation resulted due to cost push inflation.
Taking another economic scenario, suppose government expenditures increase in the economy, which increases the level of income of the people. This shifts the AD curve from AD0 to AD1. The new equilibrium point with higher price level (P1) and output (Y1) is point E1. This is demand pull inflation.
When prices rise, real income of workers fall. So, workers demand more wages to keep up with the increasing prices. This causes the aggregate supply curve AS to shift from AS0 to AS1. The new point of equilibrium is E2 where price rose to P2 and output declined to Y0. Consequently, demand pull inflation gave rise to cost push inflation.
Thus, demand pull and cost push inflations operate simultaneously in the economy and cause a sustained rise in prices from P0 to P2.