WEEK 9

what can fluctuation in short-run aggregate supply cause?

business cycle fluctuation occurs when something causes temporary change in the cost of production for firms

sustained inflation

is caused by the supply of money in the economy being increased too quickly

what causes the economy to move away from potential real GDP

primary source of business cycles are fluctuations in aggregate demand generates shift in AD curve

what is the primary way to have sustained inflation in the AS-AD model

to have aggregate demand persistently increase at a rate that is quicker than the rate of growth of potential real GDP overtime LAS curve shifts to the right as potential real GDP grows

when does inflation occur

when price levels rise

what happens when the aggregate demand curve shifts to the right every year faster than the rightward shift of the LAS curve

will create sustained inflation every year

cost push inflation episode

1. an increase in the cost of production shifts the SAS curve to the left 2. results in stagflation (increased inflation and recession) 3. gov policymakers take actions to push real GDP back towards potential by increasing aggregate demand (shifting AD curve rightward) 4. the rightward shift of the AD curve leads to more inflation

demand pull inflation episode

1. the AD curve shifts to the right (can be caused by any event that increases aggregate demand) 2. in the short-run, firms respond to the increase in demand by increasing prices 3. in the long-run, money wage rates rise, which shifts the SAS curve left 4. firms respond to the increase in their costs by increasing prices further

Stagflation is the result of

a decrease in short-run aggregate supply

when will the price level stop rising

after the economy reaches the new long-run equilibrium = temporary increase in inflation but no sustained inflation

Which of the following factors could start a demand-pull inflation ?

an increase in exports

If oil prices increase, then in the short run, real GDP will ________ and the price level will ________.

decrease; rise

how does inflation happen in the AS-AD model

demand pull inflation cost push inflation

Initially, demand-pull inflation will

increase both the price level and increase real GDP.

stagflation

negative shift in short-run aggregate supply recession and increased inflation happens at the same time

demand pull inflation

occurs when aggregate demand increases which shifts the AD curve to the right

cost push inflation

occurs when the cost of production increases which pushes producers to raise their prices

The government increases taxes. As a result, in the short run

real GDP and the price level will decrease.

demand-pull and/or cost-push process creates a _____ in price level

rise

if the expectation about the aggregate demand is incorrect

then inflation will be different then expected

if AD curve shifts by less than expected

then inflation will be less than expected and we will have a below full employment equilibrium

if the AD curve shifts by more than expected

then inflation will be more than expected and we will have an above full employment short-run equilibrium

when the SAS and AD curve shift at the same time

there is no above full employment in short-run equilibrium

what happens if aggregate demand is continually increased every year

workers and firms will eventually come to expect this will expect to have inflation this expectation of inflation will be built into labor contracts about the money wage rate, resulting in the money wage rate to rise this shift this SAS curve to the left at the same time as the AD curve shifts right