Econ 1010 chapter 28
- Inflation cycles occurs when the quantity of money grows faster than potential
GDP. But in the short run there are many variables contributing to its occurance.
o An inflation that starts because aggregate demand increases is called
demand pull inflation. This occurs when any factors contributing to
increase in demand occurs.
A one time rise in the price level is not an inflation, for an inflation
to proceed aggregate demand must persistently increase. As the
demand increases the labour will not be enough and as wage
increases the supply will shift up rising the price level.
The constant injection of funds will force a constant increase in
demand and as the demand increases faster than the price
counter parts the production will decrease both increasing the
price level respectively.
- Cost push inflation is an inflation caused by increase in costs.
o As raw goods price rise relative to the demand, the supply will decrease.
The government must then increase cash in the economy and thus
increasind demand back to the potential GDP but at a much higher price
level. The combination of rising inflation and decreasing real GDP is
- If inflation is expected, the fluctuations in real GDP that accompany demand pull
and cost push inflation does not occur. Instead, inflation proceeds with real GDP
at potential GDP and unemployment at its natural rate. People anticipate inflation
and thus are taking appropriate action to the expectations such as expected
increase in demand will create premature rises in wages.
o Rational expectation is the best forecast available and is based on all the
- Phillips curve is the relationship and the short run trade off between inflation and
o Short run Phillips curve shows the relationship between inflation and
unemployment holding the expected inflation rate and natural
unemployment rate constant. With a given short run aggregate supply
curve, and starting at full employment an increase in aggregate demand
lowers unemployment and increases the inflation rate thus a movement
up along the Phillips curve. Conversely a decrease in aggregate demand
increases unemployment and lowers the inflation rate, a movement down
along the short run phiilips curve. o Long run Phillips curve shows the relationship between inflation and
unemployment when the actual inflation rate equals the expected inflation
rate. The long run phillip curve shows that any expected inflation rate is
possible at the natural unemployment rate. And a decrease in expected
unemployment rate will result in shifting the curve downwards by the
Changes in natural unemployment rate will occur a change in both
the short run and long run Phillips curves.
- The mainstream business cycle theory is that potential GDP grows at a steady
rate while aggregate demand grows at