Macro 12

a demand-pull inflation spiral

Aggregate demand keeps increasing and the process just described repeats indefinitely.

several factors can increase

Although any of several factors can increase aggregate demand to start a demand-pull inflation, only an ongoing increase in the quantity of money can sustain it.

The short-run Phillips curve

shows the tradeoff between the inflation rate and unemployment rate, holding constant 1. The expected inflation rate 2. The natural unemployment rate

Changes in the Natural Unemployment Rate

A change in the natural unemployment rate shifts both the long-run and short-run Phillips curves.

start of a demand-pull inflation

Starting from full employment, an increase in aggregate demand shifts the AD curve rightward. The price level rises, real GDP increases, and an inflationary gap arises. The rising price level is the first step in the demand-pull inflation.

the start of cost-push inflation

A rise in the price of oil decreases short-run aggregate supply and shifts the SAS curve leftward. Real GDP decreases and the price level rises.

expected inflation

Aggregate demand increases, but the increase is expected, so its effect on the price level is expected. The money wage rate rises in line with the expected rise in the price level. The AD curve shifts rightward and the SAS curve shifts leftward ... so that the price level rises as expected and real GDP remains at potential GDP.

Demand-Pull Inflation

An inflation that starts because aggregate demand increases is called demand-pull inflation. Demand-pull inflation can begin with any factor that increases aggregate demand. Examples are a cut in the interest rate, an increase in the quantity of money, an increase in government expenditure, a tax cut, an increase in exports, or an increase in investment stimulated by an increase in expected future profits.

cost-push inflation.

An inflation that starts with an increase in costs There are two main sources of increased costs: 1. An increase in the money wage rate 2. An increase in the money price of raw materials, such as oil

stagflation.

The combination of a rising price level and a decreasing real GDP

Aggregate Demand Response

The initial increase in costs creates a one-time rise in the price level, not inflation. To create inflation, aggregate demand must increase. That is, the Fed must increase the quantity of money persistently.

The Long-Run Phillips Curve

The long-run Phillips curve shows the relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate.

Money Wage Rate Response

The money wage rate rises and the SAS curve shifts leftward. The price level rises and real GDP decreases back to potential GDP.