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Chapter 12_Inflation - INFLATION CHAPTER 1 2 Objectives...

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INFLATION 12 CHAPTER
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Objectives After studying this chapter, you will able to Distinguish between inflation and a one-time rise in the price level Explain how demand-pull inflation is generated Explain how cost-push inflation is generated Describe the effects of inflation Explain the short-run and long-run relationships between inflation and unemployment Explain the short-run and long-run relationships between inflation and interest rates
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From Rome to Rio de Janeiro Inflation is a very old problem and some countries even in recent times have experienced rates as high as 40% per month. The United States has low inflation now, but during the 1970s the price level doubled. Why does inflation occur, how do our expectations of inflation influence the economy, is there a tradeoff between inflation and unemployment, and how does inflation affect the interest rate?
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Inflation and the Price Level Inflation is a process in which the price level is rising and money is losing value. Inflation is a rise in the price level, not in the price of a particular commodity. And inflation is an ongoing process, not a one-time jump in the price level.
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Inflation and the Price Level Figure 28.1 illustrates the distinction between inflation and a one-time rise in the price level.
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Inflation and the Price Level The inflation rate is the percentage change in the price level. That is, where P 1 is the current price level and P 0 is last year’s price level, the inflation rate is [( P 1 P 0 )/ P 0 ] × 100 Inflation can result from either an increase in aggregate demand or a decrease in aggregate supply and be Demand-pull inflation Cost-push inflation
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Demand-Pull Inflation Demand-pull inflation is an inflation that results from an initial increase in aggregate demand. Demand-pull inflation may begin with any factor that increases aggregate demand. Two factors controlled by the government are increases in the quantity of money and increases in government purchases. A third possibility is an increase in exports.
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Demand-Pull Inflation Initial Effect of an Increase in Aggregate Demand Figure 28.2(a) illustrates the start of a demand- pull inflation Starting from full employment, an increase in aggregate demand shifts the AD curve rightward.
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Demand-Pull Inflation Real GDP increases, the price level rises, and an inflationary gap arises. The rising price level is the first step in the demand-pull inflation.
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Demand-Pull Inflation Money Wage Rate Response Figure 28.2(b) illustrates the money wage response. The higher level of output means that real GDP exceeds potential GDP—an inflationary gap.
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Demand-Pull Inflation The money wages rises and the SAS curve shifts leftward. Real GDP decreases back to potential GDP but the price level rises further.
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Demand-Pull Inflation A Demand-Pull Inflation Process Figure 28.3 illustrates a demand-pull inflation spiral.
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