Introduction to Finance

Price Changes Initiated by a Change in the Money Supply 
 
Demand-pull 
infl ation 
occurs when an excessive demand for goods and services is created during periods 
of economic expansion as a result of large increases in the money supply. While changes in 
the velocity, or turnover, of money can also impact price changes, we focus our discussion on 
changes in the supply of money. 
An increase in the money supply occurs when the Fed purchases government securities 
through its open-market operations. If this happens when people and resources are not fully 
employed, the volume of trade goes up; prices are only slightly aff ected at fi rst. As unused 
resources are brought into use, however, prices will go up. When resources, such as metals, 
become scarce, their prices rise. As any resource begins to be used up, the expectation of 
future price rises will itself force prices up, because attempts to buy before such price rises 
will increase demand above current needs. Since some costs will lag—such as interest costs 
and wages set by contract—profi ts will rise, increasing the demand for capital goods.
Once resources are fully employed, the full eff ect of the increased money supply will be 
felt on prices. Prices may rise out of proportion for a time as expectations of higher prices lead 
to faster spending and so raise the velocity of money. The expansion will continue until trade 
and prices are in balance at the new levels of the money supply. Velocity will probably drop 
somewhat from those levels during the period of rising prices, since the desire to buy goods 
before the price goes up has disappeared.
Even if the supply of money is increased when people and resources are fully employed, 
prices may not go up proportionately. Higher prices increase profi ts for a time, and so lead to 
a demand for more capital and labor. Thus, previously unemployed spouses, retired workers, 
and similar groups begin to enter the labor force. Businesses may use capital more fully by 
having two or three shifts use the same machines.
Demand-pull infl ation traditionally exists during periods of economic expansion when 
the demand for goods and services exceeds the available supply of such goods and services. 
Demand-pull infl ation may also be caused by changes in demand in particular industries. The 
demand for oil and natural gas, for example, may be greater than demand in general, so that 
prices rise in this industry before they rise generally. The fi rst rise is likely to be in the price 
of basic materials themselves, leading to increased profi ts in the industries that produce them. 
Labor will press for wage increases to get its share of the total value of output, and thus labor 
costs also rise. Price increases in basic industries lead to price increases in the industries that 
use their products. Wage increases in one major industry are also likely to lead to demands for