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Demand-pull inflation occurs when an increase in aggregate demand pulls up the price level ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 1 AS2 Price Level ASLR P3 c b P2 P1 AS1 a AD2 AD1 Qf Q2 Real Domestic Output ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 2 In the short run, demand-pull inflation drives up prices and output In the long run, output is restored to GDPf and only the price level is higher ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 3 Cost-push inflation arises from factors that increase the cost of production at each price level ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 4 Price Level ASLR AS1 c P3 P2 AS2 b a P1 AD2 AD1 Q2 Q f Real Domestic Output LO2 ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 18-5 5 If government attempts to maintain full employment, an inflationary spiral may occur Otherwise, the recession will linger, with high unemployment and a loss of real output ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 6 Price Level ASLR AS2 a P1 P2 AS1 b c P3 AD1 AD2 Q1 Qf Real Domestic Output LO2 ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 18-7 7 Consumer Goods Increase in production possibilities LO2 Long Run Aggregate Supply Price Level Capital Goods Productions Possibilities ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 Real GDP Increase in long-run aggregate supply 18-8 8 How long would it take in the real world for price and wage adjustments to occur to regain full employment? There is disagreement among economists ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 9 Modern economies tend to experience positive rates of inflation due to Economic growth causing rightward shifts of the AS curve Central banks then cause rightward shifts of the AD curve so that it proceeds just a little faster than the deflationary rightward shifts of the AS curve The net effect is (usually) a small positive rate of inflation ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 10 ASLR1 ASLR2 AS2 Price level AS1 P2 P1 AD2 AD1 0 Q1 Q2 Real GDP ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 11 Economic growth causes increases in long-run aggregate supply Whether deflation, or inflation accompanies growth depends on the extent to which aggregate demand increases relative to aggregate supply Any inflation that occurs is the result of growth of aggregate demand It is not the result of the growth of real GDP ©2013 McGraw-Hill Ryerson Ltd. Chapter 15, LO2 12