Business Economics BUECO5903: Inflation, AD-AS, and Economic Events

This assignment solution addresses key macroeconomic concepts, including demand-pull and cost-push inflation, and analyzes the impact of various economic events using the aggregate demand-aggregate supply (AD-AS) model. It illustrates the causes of both types of inflation and the effect...Read More

BUSINESS ECONOMICS
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Question 3
(a) The diagram highlighting the demand pull inflation is exhibited below.
It is evident that the key cause leading to demand pull inflation is the increase in aggregate
demand which causes the AD curve to shift from the right. Meanwhile the AS curve does not
exhibit any change. The resultant equilibrium point indicates a higher price and higher real
output (Mankiw, 2014).
The diagram highlighting the cost push inflation is exhibited below.
There is rise of production costs and hence the AS decreases leading to shift on the left side
(AS1 to AS2). Meanwhile the AD curve does not exhibit any change. The resultant
equilibrium point indicates a higher price (P2) and lower real output (Y2) (Koutsoyiannis,
2013).
(b) Demand pull is attributed to the following reasons (Krugman and Wells, 2014).

(i) Money supply increase– When there is a money supply increase, then there would be a
drop in the interest rates and consequently higher borrowings leading to increased spending
by consumers.
(ii) Lower tax burden – Another reason which may lead to demand pull inflation is the
lowering tax rate which would enhance the disposable income for the consumers leading to
higher consumption related expenditure and aggregate demand.
Cost push is attributed to the following reasons (Koutsoyiannis, 2013).
(i) Raw material rising cost – The costs of production would increase owing to higher costs
associated with raw material procurement and this would lead to lower supply since some
inefficient producers may shut down.
(ii) Increase in labour cost – The costs of production may also increase on account of the hike
in wages or salaries of workers and employees which would lower the margins especially if
the higher price cannot be passed to consumers. As a result, there would be lower supply and
consequently higher price.
Question 5
(a) There would be an adverse impact on consumption as the marketing skills of the people
worsen which would lead to aggregate demand fall. The relevant graph indicating this is
illustrated as follows.

The AD curve has shifted to the left while in the short run the AS curve shows no change.
The net result is that the real output and price both witness a decrease as highlighted above
(Mankiw, 2014).
(b) As the imports would increase, there would a decrease in net exports which would
effectively reduce aggregate demand. The relevant graph indicating this is illustrated as
follows.
The AD curve has shifted to the left while in the short run the AS curve shows no change.
The net result is that the real output and price both witness a decrease as highlighted above
(Koutsoyiannis, 2013).
(c) The supply is dependent on the presence of capital stock which in this case has ben
damaged and hence there would be a reduction in aggregate supply. The relevant graph
indicating this is illustrated as follows (McConnell, Brue & Flynn, 2014).

The AS curve has shifted to the left while in the short run the AD curve shows no change.
The net result is that the real output would witness a decrease and price would increase as
highlighted above (Krugman &Wells, 2014).
(d) There is reduction is tax on personal income which would increase the consumer
disposable income and hence enhance consumption expenditure. The net result is that the
aggregate demand would increase. The relevant graph indicating this is illustrated as follows
(McConnell, Brue & Flynn, 2014).
The AD curve has shifted to the right while in the short run the AS curve shows no change.
The net result is that the real output and price both witness an increase as highlighted above
(Koutsoyiannis, 2013).

References
Koutsoyiannis, A. (2013) Modern Macroeconomics. 4th ed. London: Palgrave McMillan.
Krugman, P. & Wells, R. (2014) Macroeconomics. 3rd ed. London: Worth Publishers.
Mankiw, G. (2014) Principles of Macroeconomics. 6th ed. London: Cengage Learning.
McConnell, C., Brue, S. & Flynn, S. (2014) Macroeconomics: Principles, Problems, &
Policies. 20th ed. New York: McGraw Hill Publications.