INFLATION

A significant and persistent increase in the price level

bull httpwwwinvestopediacomuniversityinflationinflation1asp

Inflation and the Price Level

bull Inflation is a process in which the price level is rising and

bull money is losing valuebull Inflation is a rise in the price level not in

the price of abull particular commoditybull And inflation is an ongoing process not a

one-time jump inbull the price level

Deflation

bull A drop in the overall price level

Inflation and the Price Level

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

bull httpwwwinvestopediacomuniversityinflationinflation1asp

Inflation and the Price Level

bull Inflation is a process in which the price level is rising and

bull money is losing valuebull Inflation is a rise in the price level not in

the price of abull particular commoditybull And inflation is an ongoing process not a

one-time jump inbull the price level

Deflation

bull A drop in the overall price level

Inflation and the Price Level

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Inflation and the Price Level

bull Inflation is a process in which the price level is rising and

bull money is losing valuebull Inflation is a rise in the price level not in

the price of abull particular commoditybull And inflation is an ongoing process not a

one-time jump inbull the price level

Deflation

bull A drop in the overall price level

Inflation and the Price Level

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Deflation

bull A drop in the overall price level

Inflation and the Price Level

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Inflation and the Price Level

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Inflation and the Price Level

bull The inflation rate is the percentage change in the pricebull levelbull That is where P1 is the current price level and P0 is lastbull yearrsquos price level the inflation rate isbull [(P1 ndash P0)P0] times 100bull Inflation can result from either an increase in aggregatebull demand or a decrease in aggregate supply and bebull 1048707 Demand-pull inflationbull 1048707 Cost-push inflation

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Causes of Inflation

bull Inflation is an increase in the overall price level

bull Sustained inflation occurs when the overall price level continues to rise over some fairly long period of time

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Stagflation

bull A condition of concurrent high unemployment (stagnation) and inflation

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Cost-Push Inflation

bull An inflation triggered by increases in input prices

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Causes of Inflationbull Demand-pull inflation is inflation initiated

by an increase in aggregate demandbull Cost-push or supply-side inflation is

inflation caused by an increase in costs

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

bull An inflation caused by high levels of demand

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Demand

bull The total quantity of commodities that are demanded at various prices

bull Total spending in economy at alternative price levels

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Supply

bull Total output of the economy at alternative price levels

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

bull Changes in aggregate demand and supply cause the

bull equilibrium price level and real GDP to change

bull resulting in business cycles

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Demand Aggregate Supplyand Business Cycles

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand Pull Inflation-Cost PushInflation

bull Demand-pull inflation inflation causedby increasing demand for output

bull Cost-push inflation inflation caused byrising cost of production

bull Examplesbull Home prices

bull Oil prices

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Demandand Business Cycles

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Supplyand Business Cycles

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Factors that affect AD

bull AD = C+I+G+NXbull CONSUMPTIONbull Income wealth expendituredemographicstaxes

bull INVENSTEMENTbull Interest rates Technology Cost of capital goods

Capacity of utilization

bull GOVERNMENT SPENDINGbull NET EXPORTSbull Domestic and foreign income Domestic and foreign

prices Exchange rates Government policy

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Why the Aggregate DemandCurve Slopes Downward

bull bull The reasons for its downward slope are

bull price-level effects

bull ndash Wealth Effect (Real WealthReal Balances)

bull ndash Interest Rate Effect

bull ndash International Trade Effect (Substitution)

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate demand curve

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Shifting theAggregate

Demand Curve

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of aChange inAggregateDemand

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

bull Demand-pull inflation rapid increases in AD outpace the growth of AS causing price level increases (inflation)

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Aggregate Supply

Aggregate Supply (AS) is the total of all the firm (market) supply curves It shows the quantity of real GDP produced at different price levels

Short-run AS slopes upward because an increase

in the price level (while production costs and

capital are held constant on the short-run) means

higher profit marginsmdashfirms will want to produce

more

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

AggregateSupply

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Shape of Short-run AS (SRAS)

bull bull In the short-run the capital stock (thebull number of factories and machines etc) arebull held constantbull bull Increasing the number of workers increasesbull output but at a diminishing ratebull bull Diminishing returns manifest as an ever

steeperbull SRAS curve

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

The Shape of theShort-Run Aggregate Supply Curve

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

The Shape of Long-run AS (LRAS)

bull bull Resource costs are NOT fixedbull ndash As prices rises workers will want higher wages andbull will eventually get thembull bull The amount of capital is not fixedmdashfirms canbull build new plants and buy new equipment over thebull long-runbull bull In the long-run AS is set by the productionbull possibilities curvemdashthe capacity of the economybull and is not affected by prices hence is vertical

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

The Shape of theLong-RunAggregate

Supply Curve

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Shifting the Long-RunAggregate Supply Curve

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Changes inAggregate

Supply

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

AggregateDemand and

SupplyEquilibrium

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

bull Demand-pull inflation is an inflation that results from anbull initial increase in aggregate demandbull Demand-pull inflation may begin with any factor thatbull increases aggregate demandbull Two factors controlled by the government are increases

inbull the quantity of money and increases in governmentbull purchasesbull A third possibility is an increase in exports

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

Initial Effect of anIncrease in AggregateDemandFigure 282(a) illustratesthe start of a demand-pullinflationStarting from fullemployment an increasein aggregate demandshifts the AD curverightward

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

Real GDP increases theprice level rises and aninflationary gap arisesThe rising price level is thefirst step in the demand pullinflation

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

Money Wage RateResponseFigure 282(b) illustratesthe money wage responseThe higher level of outputmeans that real GDPexceeds potential GDPmdashan inflationary gap

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

The money wages risesand the SAS curve shiftsleftwardReal GDP decreases backto potential GDP but theprice level rises further

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

A Demand-Pull InflationProcessFigure 283 illustrates ademand-pull inflationspiralAggregate demand keepsincreases and the processjust described repeatsindefinitely

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Demand-Pull Inflation

Although any of severalfactors can increaseaggregate demand to starta demand-pull inflationonly an ongoing increasein the quantity of moneycan sustain itDemand-pull inflationoccurred in the UnitedStates during the late1960s and early 1970s

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Cost-Push Inflation

bull Cost-push inflation is an inflation that results from an

bull initial increase in costsbull There are two main sources of increased

costsbull 1048707 An increase in the money wage ratebull 1048707 An increase in the money price of raw

materials such asbull oil

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull Unanticipated Inflation in the Labor Market

bull Unanticipated inflation has two main consequences in the

bull labor market

bull 1048707 Redistributes of income

bull 1048707 Departure from full employment

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflationbull Higher than anticipated inflation lowers the real wage ratebull and employers gain at the expense of workersbull Lower than anticipated inflation raises the real wage ratebull and workers gain at the expense of employersbull Higher than anticipated inflation lowers the real wage ratebull increases the quantity of labor demanded makes jobsbull easier to find and lowers the unemployment ratebull Lower than anticipated inflation raises the real wage ratebull decreases the quantity of labor demanded and increasesbull the unemployment rate

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull Unanticipated Inflation in the Market for Financialbull Capitalbull Unanticipated inflation has two main consequences in

thebull market for financial capital it redistributes income andbull results in too much or too little lending and borrowingbull If the inflation rate is unexpectedly high borrowers gainbull but lenders losebull If the inflation rate is unexpectedly low lenders gain butbull borrowers lose

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull When the inflation rate is higher than anticipated the real

bull interest rate is lower than anticipated and borrowers want

bull to have borrowed more and lenders want to have loanedbull lessbull When the inflation rate is lower than anticipated the realbull interest rate is higher than anticipated and borrowersbull want to have borrowed less and lenders want to havebull loaned more

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull Forecasting Inflationbull To minimize the costs of incorrectly anticipating inflationbull people form rational expectations about the inflation ratebull A rational expectation is one based on all relevantbull information and is the most accurate forecast possiblebull although that does not mean it is always right to thebull contrary it will often be wrong

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

Anticipated InflationFigure 287 illustrates ananticipated inflationAggregate demandincreases but the increaseis anticipated so its effecton the price level isanticipated

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull The money wage ratebull rises in line with thebull anticipated rise in the pricebull levelbull The AD curve shiftsbull rightward and the SASbull curve shifts leftward sobull that the price level rises asbull anticipated and real GDPbull remains at potential GDP

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull Unanticipated Inflationbull If aggregate demand increases by more than expectedbull inflation is higher than expectedbull Money wages do not adjust enough and the SAS curvebull does not shift leftward enough to keep the economy at

fullbull employmentbull Real GDP exceeds potential GDPbull Wages eventually rise which leads to a decrease in thebull SAS

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull The economy experiences more inflation as it returns to

bull full employment

bull This inflation is like a demand-pull inflation

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull If aggregate demand increases by less than expected

bull inflation is less than expectedbull Money wages rise too much and the SAS

curve shiftsbull leftward more than the AD curve shifts

rightwardbull Real GDP is less than potential GDPbull This inflation is like a cost-push inflation

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Effects of Inflation

bull The Costs of Anticipated Inflationbull Anticipated inflation occurs at full employment

with realbull GDP equal to potential GDPbull But anticipated inflation particularly high

anticipatedbull inflation inflicts three costsbull 1048707 Transactions costsbull 1048707 Tax effectsbull 1048707 Increased uncertainty

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Interest Rates and Inflation

bull How Interest Rates are Determinedbull The real interest rate is determined by investment

demandbull and saving supply in the global capital marketbull The real interest rate adjusts to make the quantity ofbull investment equal the quantity of savingbull National rates vary because of differences in riskbull The nominal interest rate is determined by the demand

forbull money and the supply of money in each nationrsquos moneybull market

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Interest Rates and Inflation

bull Why Inflation Influences the Nominal Interest Rate

bull Inflation influences the nominal interest rate to maintain an

bull equilibrium real interest rate

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Expectations and Inflation

bull If every firm expects every other firm to raise prices by 10 every firm will raise prices by about 10 This is how expectations can get ldquobuilt into the systemrdquo

bull In terms of the ADAS diagram an increase in inflationary expectations shifts the AS curve to the left

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Money and Inflation

bullHyperinflation is a period of very rapid increases in the price level

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Money and InflationbullAn increase in G with the money supply constant shifts the AD curve from AD0 to AD1

bullThis leads to an increase in the interest rate and crowding out of planned investment

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Money and Inflation

bullIf the Fed tries to prevent crowding it will increase the money supply and the AD curve will shift farther and farther to the right

bull The result is a sustained inflation perhaps hyperinflation

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Long-Run Aggregate Supply Curve

bull The vertical line reflecting the natural level of output that the economy will produce in the long run regardless of the price level (full employment is assumed)

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Phillips Curve

bull A curve showing an inverse relationship between inflation rate and unemployment rate in the short run

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

The Phillips Curve

Inflation

Unemployment

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

Supply Shock

bull A change in technology or supply of raw materials that shifts the short-run aggregate supply curve

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

An Adverse Supply Shock as a Cause of Cost-Push Inflation

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67

• INFLATION
• Slide 2
• Inflation and the Price Level
• Deflation
• Slide 5
• Slide 6
• Causes of Inflation
• Stagflation
• Cost-Push Inflation
• Slide 10
• Demand-Pull Inflation
• Aggregate Demand
• Aggregate Supply
• Slide 14
• Aggregate Demand and Aggregate Supply Curves ( Short-Run amp Long-Run)
• Aggregate Demand Aggregate Supply and Business Cycles
• Demand Pull Inflation-Cost Push Inflation bull Demand-pull inflation inflation caused by increasing demand for output bull Cost-push inflation inflation caused by rising cost of production bull Examples bull Home prices bull Oil prices
• Aggregate Demand and Business Cycles
• Aggregate Supply and Business Cycles
• Factors that affect AD
• Why the Aggregate Demand Curve Slopes Downward
• Aggregate demand curve
• Shifting the Aggregate Demand Curve
• Effects of a Change in Aggregate Demand
• Slide 25
• Slide 26
• Slide 27
• Shape of Short-run AS (SRAS)
• The Shape of the Short-Run Aggregate Supply Curve
• The Shape of Long-run AS (LRAS)
• The Shape of the Long-Run Aggregate Supply Curve
• Shifting the Long-Run Aggregate Supply Curve
• Changes in Aggregate Supply
• Aggregate Demand and Supply Equilibrium
• Slide 35
• Slide 36
• Slide 37
• Slide 38
• Slide 39
• Slide 40
• Slide 41
• Slide 42
• Effects of Inflation
• Slide 44
• Slide 45
• Slide 46
• Slide 47
• Slide 48
• Slide 49
• Slide 50
• Slide 51
• Slide 52
• Slide 53
• Slide 54
• Interest Rates and Inflation
• Slide 56
• Expectations and Inflation
• Money and Inflation
• Slide 59
• Slide 60
• Slide 61
• Long-Run Aggregate Supply Curve
• Phillips Curve
• The Phillips Curve
• Supply Shock
• An Adverse Supply Shock as a Cause of Cost-Push Inflation
• Slide 67