Answer: Cost push inflation starts with a decrease in the short-run aggregate supply, that is, a leftward shift of the SAS curve. The decrease in short-run aggregate supply can be the result of an increase in the money wage rate or an increase in the money price of other raw materials. In either instance firms' costs have risen and they respond by decreasing production, which decreases the short-run aggregate supply. The dilemma for the Fed is that the decreases in short-run aggregate supply means that real GDP falls below potential GDP and the price level rises. If the Fed responds by increasing the quantity of money in order to increase aggregate demand and move real GDP back to potential GDP, the price level will rise still higher. And if the initial agent that raised costs responds to the higher price level by again raising its costs, then a cost-push inflation might well occur.
Answer:
ReplyDeleteCost push inflation starts with a decrease in the short-run aggregate supply, that is, a leftward shift of the SAS curve. The decrease in short-run aggregate supply can be the result of an increase in the money wage rate or an increase in the money price of other raw materials. In either instance firms' costs have risen and they respond by decreasing production, which decreases the short-run aggregate supply. The dilemma for the Fed is that the decreases in short-run aggregate supply means that real GDP falls below potential GDP and the price level rises. If the Fed responds by increasing the quantity of money in order to increase aggregate demand and move real GDP back to potential GDP, the price level will rise still higher. And if the initial agent that raised costs responds to the higher price level by again raising its costs, then a cost-push inflation might well occur.