Chapter 28 Canadian Inflation , Unemployment and Business Cycle
Inflation (an ongoing process of rising in price level)
-Can occurs when money grows faster than Potential GDP
(Potential GDP is when labour is fully employed; and
the quantity of real GDP is at full
Two major sources of inflation (i) Demand-pull inflation (ii) Cost-push inflation
Demand-pull inflation=Occurs when inflation occurs when Aggregate Demand rises more rapidly than
the economy’s productive potential.
-occurred in Canada 1974
-between 1973-1974 inflation reached double digits
Aggregate demand (AD) is the total
demand for goods and services
produced in economy over a period
Examples; cut in interest rate, increase in the quantity of money, increase in
Sources of increases of aggregate demand
(i) increase in the quantity of money (SHIFTS THE GRAPH RIGHTWARD and OUT)
(ii)increase in the government expenditure
(iii)increase in exports
(iv) increase in investment
--Increase in the quantity of money (SHIFTS THE GRAPH RIGHTWARD and OUT)
-Real GDP > Potential GDP | Unemployment rate < Natural rate
--REAL GDP cannot REMAIN ABOVE POTENTIAL Forever GDP therefore ;
--Money wage rises=SAS decreases and SAS curve shifts leftward
*** ALL THIS BRINGS UP THE PRICE-LEVEL BUT DOES NOT NECESSARILY CAUSE INFLATION . TO CAUSE
INFLATION, AGGREGATE DEMAND INCREASE SHOULD BE PRESISTANT/ PERPETUAL
(this causes demand-pull inflation)
Cost-Push Inflation= inflation due to increase in costs
-Canada experienced in 1974 when OPEC raised the price of the oil four fold.
-OPEC raised the price of oil again in 1979 and 1980.
-Two main sources of increase in the cost are
(i) Increase in money wage rate (ii) Increase in the money prices of raw materials The higher the cost of production, the smaller the companies will produce. And if money wage
increases/or raw materials price then the companies will decrease the supply of their goods and services
leading to Aggregate Supply Decrease.
Aggregate supply (AS) is the total
Supply for goods and
services produced in economy over
a period of time.
AS decreases, SAS shifts leftward as the money/raw materials price increases.
Unemployment > Natural Rate | Price level rises and Real GDP decreases
Rise in the price of oil due to higher prices of everything. So to keep the real oil revenues constant.
This action decreases SAS. The short run aggregate supply curve will shift leftward.
The economy experiencing both unemployment and a rise in the price level is called Stagflation.
-Bank of Canada needs to increase the money for inflation to succeed and restore full employment
Demand-Pull Inflation Cost-Push Inflation
Triggered by increase in aggregate demand Triggered by increase in money wage rate or raw
money growth material prices , money growth
Real GDP >full employment (potential GDP) Real GDP < Potential GDP
Effects of Inflation
Anticipated Inflation Unanticipated Inflation
When people/businesses can make ac