Under demand-pull inflation, we have shown how expansion in aggregate demand without a proportionate increase in the supply of goods and services leads to an inflationary situation. However, it is not necessary to have a general increase in demand to bring about inflationary pressure. Sometimes, the increase in demand may be confined to some sector of the economy and this increase in demand and the consequent rise in the price in a particular sector may spread to other sectors. Suppose the demand for agricultural goods rises because of inadequate supplies of these goods, there would be a consequent rise in the price of agricultural goods. Thus, the rise in prices spreads to all other sectors in the economy, through rise in the prices of raw materials and wages. The rise in prices in the agricultural sector may push up prices in the industrial sector. Therefore, the inflationary rise in the price level is due to sectoral shifts in demand.
The “sectoral demand theory” of inflation emphasizes the fact that prices are highly flexible upwards but relatively rigid downwards, for example, there may be rise in prices in the agricultural sector where there is scarcity whereas price stability in the industrial sector where there is an excess supply. However, in course of time, prices all over the economy will assume an upward trend. The “sectoral demand theory” is also useful to explain the simultaneous existence of inflation and recession, i.e., inflation in some sectors and recession in certain other sectors. Industries coming under inflationary pressure will experience persistent rise in price but industries suffering from recession may not experience a fall in the price level. Modern economists have coined the word “Stagflation” to refer to this situation in which stagnation in some sectors of the economy is present while other sectors are subject to a highly inflationary situation.