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2.4 B Types or Causes of INFLATION:

2.4 B Types or Causes of INFLATION:. B & D pages 230-232. Learning Objective. Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD.

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2.4 B Types or Causes of INFLATION:

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  1. 2.4 BTypes or Causes of INFLATION: B & D pages 230-232

  2. Learning Objective • Explain, using a diagram, that demand-pull inflation is caused by changes in the determinants of AD, resulting in an increase in AD. • Explain, using a diagram, that cost-push inflation is caused by an increase in the costs of factors of production, resulting in a decrease in SRAS. • Explain the monetarists’ view of the cause of inflation.

  3. Price Level Aggregate supply P1 D2 Aggregate demand Y1 Short Run Demand-Pull Inflation: is caused by “positive” changes in AD components P2 D1 Y2 0 GDP

  4. P4 AD4 P3 P2 AD3 P1 AD2 AD1 Y1 Y2 Yf Y3 Using the Keynesian model, increasing AD leads to growth but “manageable” inflation – only on the “flat” portion of AS Price level O GDP / Y

  5. A cause-effect “spiral” may result in ongoing inflation:a demand pull spiral occurs when inflationary expectations set in. Workers try to keep pace by….

  6. AS2 Price Level P2 Aggregate supply P1 Aggregate demand Y2 Y1 Short Run Cost-Push Inflation: is caused by AS supply “shocks” of sudden rising producer costs 0 GDP

  7. Stagflation may occur if a cost-push spiral sets in Usually Aggregate Supply curves increase at a steady rate. Every now and then, however, a ‘supply shock’ occurs: a large, sudden event will cause the AS curve to contract. Such as: • crude oil price rise (transportation and energy costs) • Natural disaster (earthquake destroying infrascuture) • Increase Excise (indirect taxes) introduction This combination of recession and inflation was named Stagflation back in the 1970s – as it was unprecedented and first exposed the weakness of Keynesian “demand side” macroeconomic management.

  8. Task: illustrate and explain the steps in a cost-push spiral starts with __________ AS “shock” such as… then inflationary expectations feeds aggregate demand because…. And in turn causes _____________ inflation because…

  9. Key differences with a cost-push spiral: starts with decreasing AS (cost push) “shock” such as…then inflationary expectations feeds demand-pull because…

  10. AS” B PL” 2. AS decreases due to rising wage and input costs PL 3. Price Level rises and Output returns to Capacity GDP. 1.The increase in AD opens up the Inflationary Gap A 4.In the long Run higher prices have resulted in a movement from A to B, giving us a vertical AS curve at capacity GDP AD’ Y’ #3 excess monetary growth inflation:Increases in AD beyond Yf will ultimately fail to increase growth; and only “fuel” inflation Capacity GDP Price level AS AD Real GDP Y

  11. Deflation: the Good, the Bad and the Ugly

  12. AS” A 2. Wage and resource costs will eventually adjust downwards, increasing AS B PL’ 3. Price Level falls further and while real output may increase, AD may decrease again. 1. If deflationary expectations set in, AD worsens a recessionary gap PL” AD’ Y’ How the economy responds to a malignant deflation: By further deflation! What is the risk? Capacity GDP Price level AS PL AD Y Real GDP

  13. Tasks: Quiz B and Explain and Evaluate the impact of Deflation!

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