Just Keynesian

November 22 year 2014

4b) Discuss whether inflation is more likely to be caused by a shift in an
economics aggregate demand or shift in its aggregate supply (12)
Answer:
Note: AD=Aggregate Demand, RGDP= Real Gross Domestic Product,
SRAS=Short run aggregate supply, PL=Price level
Inflation is the a general increase in the price level of goods in the a country. It
causes the purchasing power to decrease as the people are now able to
purchase lesser goods with the same amount of money as before. A decrease in
purchasing power also means a fall in the real value of money that the money is
now worth less. There are 2 two main Inflations which is are demand pull
inflation (Shift in AD) and cost push inflation (Shift in SRAS)
Firstly Demand pull inflation is caused by an increase in the AD as a whole in
the country; when there is an increase in AD increases both the price level and
the RGDP will increase as shown in the diagram 1. (Shown in diagram 1). There
are many causes of increase in AD. When Increase in consumer spending,
government spending, investment and net export increases this will cause AD
to shift right, and incurring demand pull inflation therefore PL increase and
RGDP increase. Same goes for import, when import decrease PL and RGDP too
will increase because when people dont buy imported goods they buy
domestic goods. Not only that, AD can also increase when there is an excess
increase in money supply. Higher money supply is likely to increase the nominal
income of consumers for when causing them to increase the demand on goods
and services the consumer has more money (Given that they are rational),
demand will increase
Second cause of inflation is Cost push inflation which is cause by a decrease in
SRAS, diagram 2 shows that when SRAS decrease, PL increases but RGDP
decreases (Shown in diagram 2). There are many causes of decrease in SRAS
and but it is mostly is due to the reduction in raw materials and an increase in
the cost of production. Example: when there is increase in the prices of raw
materials (government taxation, higher imported price), when there is a natural
disaster causing the supply of goods to decrease, when the increase in the
wage rate is more than increase in productivity etc.
To know answer the question which inflation is more likely to happen, it is
useful to analyze we are to see which are the variables that fluctuate more
often of the causes are easier to affect the shift in AD and SRAS. As a
comparison, we could see that consumer spending, government spending,

investment, export and import are more likely to happened change compared
to changed in raw material and the cost of production. This is because the
expenditure behavior of various agents in an economy is sensitive to the
change of economic conditions and thus the change in their expenditure can be
volatile. The fluctuation of cost of production in an economy can be very
minimal. because in short run the price cannot change immediately and it may
also First, due to sticky wage the cost of labour is expected to be stable in short
run. and as the above example of Second, natural disasters can affect the
supply of raw materials but they do not happen frequently. it will not always
happen and cause supply to decrease. Third, producers at large have much
concern about the cost of production and will take various measures to hedge
against the increase in of price of raw materials. Therefore in Since conclusion
the shift of AD is more likely to happened, it is concluded and this also means
that demand pull inflation are more likely to happen than compared to cost
push inflation.

(Demand pull inflation)

Attention:
If you have mentioned
diagram 1 and 2 in your
essay, make sure that you
label your diagrams
accordingly.

(Cost push Inflation)

November 23 Year 2014

3a) Explain why an increase in the money supply and rising world energy
prices are categorized as different causes of inflation in an economy (8)
Answer:
Note: AD=Aggregate Demand, RGDP= Real Gross Domestic Product,
SRAS=Short run aggregate supply, PL=Price level
Inflation is a general and sustained increase in prices. There are few types of
Inflation that are categorized differently due to the different of based on the
cause of the inflation.
Firstly there is inflation called Demand pull inflation, This is an inflation which
happens occurs when there is due to an increase in the total demand for goods
and services on economy when the economy is at or close to maximum
capacity.
There are also an inflation called the Monetary inflation, this is caused by an
increase in the money supply which decrease the real value of the money and
cause an increase in general price level. Monetary inflation is also related to
can trigger demand pull inflation because as people hold more money they
tend to buy more increase their demand, leading and this will lead back again
to demand pull inflation. When the increase in the AD is not matched by an
equivalent increase in AS, price level will increase, these impacts are shown in
diagram 1and RGDP will also increase (Drawn in diagram 1).
Another inflation is called Cost push inflation, this inflation is caused by an
increased in the cost of production. A rise in world energy prices would
increase the cost of production and therefore it is categorized as cost push
inflation. As the minimum supply price that sellers request increases, SRAS
curve shift leftward and this cause the PL to increase and the RGDP to
decrease, as shown in diagram 2 (Drawn in diagram 2)
In conclusion, an increase in money supply increases AD, more than AS of the
economy therefore causing both PL and RGDP increase if the increase of AD
outweighs the increase of AS, the increase in money supply leads to monetary
inflation. while An increase in world energy prices increases the cost of
production and leads to cost push inflation decreases the AS of an economy
causing PL to increase and RGDP to decrease. Inflation caused by an increase in
money supply is different from inflation caused by the rising world energy
prices because they are affected triggered by different factors: the increase in
money supply and the increase in cost and these factors can be monetary
factors, demand pull factors or cost push factors.

Attention:
If you have mentioned
diagram 1 and 2 in your
essay, make sure that you
label your diagrams
accordingly.