Canadian Inflation, Unemployment, and Business Cycle
• 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
• 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
• 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-
• 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