ECON102 Chapter 28: 28
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The mainstream business cycle theory is that potential gdp grows at a steady rate while aggregate demand grows at a fluctuating rate. Money wage rate is sticky, if aggregate demand grows faster than potential gdp, real gdp moves above potential gdp and inflationary gap emerges. If aggregate demand grows slower than potential gdp, real gdp moves below potential gdp and a recessionary gap emerges. If aggregate demand decreases, real gdp also decreases in a recession. In the long run, inflation occurs if the quantity of money grows faster than potential gdp. In the short run, many factors can start an inflation, and real gdp and the price level interact. To study these interactions, we distinguish two sources of inflation: An inflation that starts because aggregate demand increases is called demand-pull inflation. Demand-pull inflation can begin with any factor that increases aggregate demand. Initial effect of an increase in aggregate demand.