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Inflation and Aggregate Demand and Supply

Having problems with the three questions below.

1. Consider the following price information:

Year 1 Year 2

Cup of coffee $.50 $1.00
Glass of milk $1.00 $2.00

(a) Based on the information given, what was the inflation rate between year 1 and year 2?
(b) What happened to the price of coffee relative to that of milk between year 1 and year 2?

2. Why does the aggregate demand curve slope down? Give real-world examples of the three effects that explain the slope of the curve.

3. How is the aggregate supply curve different from the supply curve for a single good like pizza?

Solution Preview

1. The inflation rate is 100% (prices have doubled).
Because the price of both coffee and milk doubled, their prices relative to each other remained the same (coffee is still half the price of milk).

2. Aggregate demand expressed the quantity purchased at different price levels. Consumers purchase more when prices are low because of both the income and substitution effects. The income effect occurs because as prices fall, their real income increases. As ...

Solution Summary

Calculation of inflation rate; understanding aggregate demand