Answer to Question #146668 in Macroeconomics for sam smith

Question

Explain, with the aid of a graph, the demand‐pull inflation. In your answer, consider the following:
 Graphical illustration of the demand‐pull inflation (5)
 Provide any three of your own examples/scenario that might cause the demand‐pull
inflation (6)
 Recommend the policy tools to use in order to curb each type of inflation mentioned
above (4)

Answer 1

Increased employment makes aggregate demand (AD) to increase, which leads to increased hiring by firms to increase output. Due to capacity problems, this increament of output will later change to so small that the cost of the good will go up. At first, unemployment will go down, changing AD1 to AD2, which increases demand (demand is noted as "Y") hence (Y2 − Y1). This increase in demand means more workers are needed, and then AD will be changed from AD2 to AD3, but this time much less is produced than in the previous change, but the price level has gone up from P2 to P3, a much higher increase in price than in the previous change. This increase in price is what causes inflation in an economy.

Demand pull inflation can be caused by the following instances.

1) Government increasing their spending for reasons like offering better or quality services to population at large

2) consumer increasing their spending for household for example as results of increased consumer credit availability.

3) increased export earnings for example because of increase in prices of important export products.

To curb demand pull inflation

1)Government can lower it spending or raise taxes.

2) Government can increase the interest rate hence making consumers spend less on durable goods and housing.