Question

Illustrate and briefly explain the beginning of a demand-pull inflation.

3.         When answering parts a and b, draw the relevant Phillips curve.

1. Using a short-run Phillips curve, what is the effect on the unemployment rate if the inflation rate unexpectedly rises.
2. Using a long-run Phillips curve, what is the effect on the unemployment rate if the inflation rate rises and people expect the rise.
3. Explain how your answer to part a about the unexpected rise in the inflation rate changes in part b as the inflation rate becomes expected.

4.         How is the real business cycle theory unique from the other theories of the business cycle?

Answer the following multiple choice questions.

5.         Initially, demand-pull inflation ____ the price level and ____ real GDP.

1. raises; does not change
2. raises; raises
3. raises; decreases
4. does not change; increases

6.         To prevent demand-pull inflation

1. firms must refuse to increase money wages.
2. the Fed must not let the money supply persistently rise.
3. the natural rate of unemployment must increase.
4. real GDP must increase.

7.         Cost-push inflation may initially result from

1. an increase in the quantity of money.
2. the use of new technology.
3. an increase in government purchases.
4. an increase in the cost of resources.

8.         If the natural unemployment rate increases, then the long-run Phillips curve ____ and the short-run Phillips curve ____.

1. shifts rightward shifts leftward
2. shifts rightward; shifts rightward
3. shifts rightward; does not change
4. shifts rightward; shifts leftward

9.         Business cycle events that arise solely from aggregate demand shifts are emphasized by the

1. Keynesian and real business cycle theories.
2. monetarist and real business cycle theories.
3. Keynesian and monetarist theories.
4. none of the major theories.

10.      In the real business cycle theory of a recession, the demand for loanable funds curve shifts ____, the demand for labor curve shifts ____, and the supply of labor curve shifts ____.

1. leftward; leftward; leftward
2. rightward; leftward; leftward
3. leftward; not at all; leftward
4. leftward; leftward; rightward

Answer 1

Demand pull inflation

Demand pull inflation occurs when aggregate demand exceeds aggregate supply of goods and services in the economy. In this situation, economy expands rapidly surpassing its productive capacity.

Oe reason of rising demand for goods and services is increase in money supply. Addition income raises purchasing power and demand for goods and services in the economy. The process is illustrated below:

price Long supply AS P2 AD P1 AD Real GDP Y Y2

In the figure, As demand rises, AD curve shifts rightward to AD₂ along the long run aggregate supply curve. Eventually to restore equilibrium, price rises and real GDP also rises when production .

There are other reasons of demand pull inflation such as depreciation of domestic currency. As currency depreciates, export demand increases and income also rises in domestic economy. Hence, aggregate demand rises.