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Lecture

Econ 1022 Chapter 28

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Department
Economics
Course
Economics 1022A/B
Professor
Jeannie Gillmore
Semester
Fall

Description
Chapter 28 Canadian Inflation, Unemployment, and Business Cycle Inflation Cycles • Inflation is a process in which the price level is rising and money is losing value. • Demand-pull inflation is inflation that results from an initial increase in aggregate demand. • A demand-pull inflation can result from any influence that increases aggregate demand. • In a demand-pull inflation, initially: o Aggregate demand increases o Real GDP increases above potential GDP and the price level rises o The money wage rate rises o The price level rises further and real GDP decreases toward potential GDP • A one-time increase in aggregate demand raises the price level but does not always start a demand-pull inflation. • For demand-pull inflation to occur, aggregate demand must persistently increase. • The quantity of money must persistently grow at a rate that exceeds the growth rate of potential GDP. • The figure shows a demand-pull inflation. • Initially, aggregate demand increases and the AD curve shifts rightward fr0m AD t1 AD . • Real GDP increases to $1,250 billion and the price level rises from 110 to 113. • Now real GDP exceeds potential GDP. • The money wage rate begins to rise. • The SAS curve shifts leftward from S0S to S1S . • Real GDP decreases toward potential GDP. • The price level rises further from 113 to 121. • The process repeats in an unending demand-pull inflation spiral. • Cost-push inflation is an inflation that results from an increase in costs. • The two main sources of cost-push inflation are: o An increase in the money wage rate o An increase in the money prices of raw materials • In a cost-push inflation, initially o Short-run aggregate supply decreases o Real GDP decreases below potential GDP and the price level rises o The economy could become stuck in this stagflation situation for some time. • A one-time decrease in aggregate supply raises the price level but does not always start cost- push inflation. • For cost-push inflation to occur, aggregate demand must increase in response to the cost-push. • Just like the case of demand-pull inflation, the quantity of money must persistently grow at a rate that exceeds the growth rate of potential GDP if inflation is to become persistent. • In the figure, the price of oil rises. • Short-run aggregate supply decreases and the SAS curve shifts leftward from SAS to 0AS . 1 • Real GDP decreases from $1,200 billion to $1,150 billion and the price level rises from 110 to 117. Stagflation occurs. • With no subsequent change in aggregate demand, the price level eventually falls. • The figure below shows the aggregate demand response to cost-push. • For cost-push inflation to take hold, aggregate demand must increase. • An increase in the quantity of money increases aggregate demand and the ADcurve shifts rightward from AD0to AD 1 • Real GDP increases to $1,200 billion and the price level rises to 121. • This process repeats to create an unending cost-push inflation spiral. Inflation and Unemployment: The Phillips Curve • A Phillips curve is a curve that shows a relationship between inflation and unemployment. • There are two
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