Demand-pull inflation occurs when an increase in aggregate demand pulls up the price level

1©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Real Domestic Output

Pri

ce L

evel

P1

Qf

a

AS1ASLR

AD1

AD2

AS2

c

bP2

P3

Q2

2©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

In the short run, demand-pull inflation drives up prices and output

In the long run, output is restored to GDPf and only the price level is higher

3©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Cost-push inflation arises from factors that increase the cost of production at each price level

4©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Real Domestic Output

Pri

ce L

evel

P1

Qf

a

AS1ASLR

AD1

AD2

AS2

b

c

P2

P3

Q2

LO2 18-5 5©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

If government attempts to maintain full employment, an inflationary spiral may occur

Otherwise, the recession will linger, with high unemployment and a loss of real output

6©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Real Domestic Output

Pri

ce L

evel P1

Qf

a

AS1ASLR

AD1

AD2

AS2

b

c

P2

P3

Q1

LO2 18-7 7©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Pri

ce L

evel

Real GDP

Cap

ital G

ood

s

Consumer Goods

Productions Possibilities

Long Run Aggregate

Supply

Increase in production possibilities

Increase in long-run aggregate supply

LO2 18-8 8©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

How long would it take in the real world for price and wage adjustments to occur to regain full employment?

There is disagreement among economists

9©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Modern economies tend to experience positive rates of inflation due to

Economic growth causing rightward shifts of the AS curve

Central banks then cause rightward shifts of the AD curve so that it proceeds just a little faster than the deflationary rightward shifts of the AS curve

The net effect is (usually) a small positive rate of inflation

10©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

P1

P2

Q2Q10

Pri

ce level

Real GDP

ASLR1 ASLR2

AS1

AS2

AD1

AD2

11©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2

Economic growth causes increases in long-run aggregate supply

Whether deflation, or inflation accompanies growth depends on the extent to which aggregate demand increases relative to aggregate supply

Any inflation that occurs is the result of growth of aggregate demand

It is not the result of the growth of real GDP

12©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2