macroeconomics inflation summary

Chapter 30: Inflation, unemployment and the business cycle
Types of inflation:
 Cost push inflation
 Demand pull inflation

Demand pull inflation:
 Inflation that starts because aggregate demand increase
 Can be kicked off by any factors that change AD
 Eg: cut in interest rate, increase in Q of money
 Increase in AD raises price level and increases real GDP, money wage rate rises, SAS
shifts left, Price level rises further and real GDP declines
 When unemployment is below its natural rate, there is a shortage of labor. Therefore,
money wage rate rises. As it rises, short run AS decreases and SAS shists left, price level
rises again, real GDP decreases
Cost push inflation:
 Kicked off by an increase in costs
 Main sources of increase:
o Increase in money wage rate
o Increase in money price of raw materials
 At a given PL, the higher the cost of production, the less companies are willing to
produce
 If money wage rate/prices of raw materials rises, firms decrease supply
 AS decreases & SRAS curve shists left
Deflation:
 An economy experiences deflation when it has a persistently falling price level
What causes deflation?
 Pl can fall because AD decreases or SRAS increases
 PL falls persistently if AD increases at a slower rate than AS
 Inflation Rate = money growth rate + rate of velocity change – Real GDP growth rate
Consequences of deflation
 Redistributes wealth
 Lowers Real GDP and employment
 Diverts resources from production
 Real wages rise and fewer workers are hired, level of employment ad output fall
 Investments fall, slows pace of capital accumulation, slows growth rate of potential GDP
 Low nominal interest rate, increase in quantity of money people hold, decrease in
velocity of circulation, lowers inflation rate