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Economics 1022B inflation and unemployment

The two main sources of increases in costs are an

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Unformatted text preview: two main sources of increases in costs are: – An increase in wage rates. – An increase in the prices of raw materials. Price level (GDP deflator, 1997 = 100) Cost-Push Inflation Cost-Push LAS 130 SAS1 120 117 SAS0 110 100 0 Resource price rise shifts SAS leftward shifts SAS and causes stagflation AD0 700 750 800 850 900 950 Real GDP (billions of 1997 dollars) Price level (GDP deflator, 1997 = 100) Aggregate Demand Response to Cost Push Response LAS 130 SAS1 121 117 SAS0 110 AD1 100 0 AD0 The Bank of Canada The increases AD to AD restore fullrestore employment and employment the price level rises again again 700 750 800 850 900 950 Real GDP (billions of 1997 dollars) Price level (GDP deflator, 1997 = 100) A Cost-Push Inflation Spiral Spiral LAS SAS2 133 129 SAS1 121 117 SAS0 110 100 0 AD2 AD1 Oil producers, Oil employees and the Bank of Canada feed the cost-price inflation spiral inflation AD0 700 750 800 850 900 950 Real GDP (billions of 1997 dollars) Effects of Inflation Effects Unanticipated Inflation in the Labour Market • Redistribution of income – If inflation is higher than expected, employers gain – If inflation is lower than expected, employees gain • Departure from full employment Inflation and Interest Rates Inflation Example • Have $20,000 • Car costs $22,000 • Lend $20,000 for 1 year at 10% nominal interest rate • Inflation is 5% • In 1 year you have $22,000 but car costs $23,100 • Nominal rate should have been 15.5%,...
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