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ch27 - Chapter 27 Inflation Inflation and the Price Level...

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Chapter 27 Inflation Inflation and the Price Level Inflation is a process in which the price level is rising and money is losing value. The average level of prices is rising. Inflation is not high prices and is not a jump in prices. Demand-Pull Inflation Demand-pull inflation is inflation that results from an initial increase in aggregate demand. A demand-pull inflation can result from any influence that increases aggregate demand. In a demand-pull inflation, initially: o Aggregate demand increases o Real GDP increases above potential GDP and the price level rises o The money wage rate rises o The price level rises further and real GDP decreases toward potential GDP. A one-time increase in aggregate demand raises the price level but does not always start a demand-pull inflation. For demand-pull inflation to occur, aggregate demand must persistently increase. The quantity of money must persistently grow at a rate that exceeds the growth rate of potential GDP. The figure on the next page shows a demand-pull inflation. Initially, aggregate demand increases and the AD curve shifts rightward from AD 0 to AD 1 . Real GDP increases to $1,050 billion and the price level rises from 110 to 113. Now real GDP exceeds potential GDP.
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The money wage rate begins to rise. The SAS curve shifts leftward from SAS 0 to SAS 1 . Real GDP decreases toward potential GDP. The price level rises further from 113 to 121.
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This process repeats in an unending demand-pull inflation spiral. Cost-Push Inflation Cost-push inflation is an inflation that results from an initial increase in costs. The two main sources of cost-push inflation are: o An increase in the money wage rate o An increase in the money prices of raw materials In a cost-push inflation, initially o Short-run aggregate supply decreases o Real GDP decreases below potential GDP and the price level rises o The economy could become stuck in this stagflation situation for some time.
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