Canadian Inflation, Unemployment, and Business Cycle
• Inflation is a process in which the price level is rising and money is losing
• The average level of prices is rising.
• Inflation is not high prices and is not a jump in prices.
• Demand-pull inflation is inflation that results from an initial increase in
• A demand-pull inflation can result from any influence that increases aggregate
• 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 on the next page shows a demand-pull inflation.
• Initially, aggregate demand increases and theD curve shifts rightward from
AD 0o AD .1
• Real GDP increases to $1,050 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 SAS t0 SAS . 1
• Real GDP decreases toward potential GDP.
• The price level rises further from 113 to 121. • This process repeats in an unending demand-pull inflation spiral.
• Cost-push inflation is an inflation that results from an initial 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
• 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
• 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 0o SAS .1
• Real GDP decreases from $1,000 billion to $950 billion and the price level rises
from 110 to 117 in a stagflation.
• With no subsequent change in aggregate demand, the price level eventually falls.
• The figure 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 AD
curve shifts rightward from AD 0o AD .1 • Real GDP increases to $1,000 billion and the price level rises to 121.
• This process repeats to create an unending cost-push inflation spiral.
Inflation and Unemployment: The Phillips Cur