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Inflation, Investment, and Supply Curves

Explain why a decrease in aggregate demand results in a lower level of employment, given a fixed aggregate supply.

Distinguish between two sources of inflation. Explain why steady inflation is likely to be less harmful to an economy than a situation which inflation rates vary alot.

"A rise in planned investment spending in an economy will lead to a rise in consumer spending." use the concept of the multiplier to verify this statement.

In constructing the short run aggregate supply curve, what is meant by the term "short-run"? How does this concept differ from the long run and what is the effect on industry of the difference in terms of planning? Explain the role of labor contracts on movement along the SRAS curve

Solution Preview

We can analyze this problem with an AD-AS model (see attached file). The AS curve will be upward sloping because supplies are fixed. The AD curve shifts leftward due to the decrease in consumption induced by a decline in consumer confidence. This decline in aggregate demand creates an imbalance in the aggregate market. At the existing price level (which has NOT yet changed), producers are willing and able to sell $100 billion worth of real production. Buyers, however, are now willing and able to purchase less, something like $80 billion worth of real production. This creates economy-wide product market surpluses. Motivated by a build-up of inventories created by economy-wide product market surpluses, producers decrease production. In the short run they do so by reducing the employment of resources, especially labor.

Inflation that stems from demand is called demand-pull inflation. Inflation that results from increased costs of production is called cost-push inflation.

If an increase in demand occurs, businesses will increase output by making use of all resources causing profits to rise. Prices of the product will probably not rise because an organization could lose much of its share of the market to competitors who ...

Solution Summary

Two sources of inflation, and how a decrease in aggregate demand results in a lower level of employment, given a fixed aggregate supply. How investment spending leads to a rise in consumer spending. The distinction between long and short run supply curves.