Causes of Demand-Pull vs. Cost-Push Inflation

Steps:

• Define demand-pull inflation as rising prices from excess aggregate demand, often due to higher spending.
• Define cost-push inflation as rising prices from increased production costs passed to consumers.
• Evaluate each option against these definitions to identify the accurate cause.
• Confirm D aligns with demand-pull via tax effects on disposable income.

Why D is correct:

• Lower direct taxes increase households' disposable income, boosting consumption and aggregate demand, which causes demand-pull inflation per the AD-AS model.

Why the others are wrong:

• A: Lower indirect taxes reduce production costs, easing cost-push pressures and potentially causing disinflation.
• B: Lower direct taxes stimulate demand, not production costs, so they cause demand-pull, not cost-push inflation.
• C: A rising exchange rate appreciates the currency, making imports cheaper and reducing aggregate demand, which curbs demand-pull inflation.

Final answer: D