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Chapter 28

Econ 1010 chapter 28.docx

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ECON 2500
Rebecca Jubis

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 stagflation. - 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 relevant information. - Phillips curve is the relationship and the short run trade off between inflation and unemployment. 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 difference.  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
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