Answer to Question #299466 in Macroeconomics for helly

Question

. It is sometimes argued that economic growth that is "too rapid" will be associated with inflation. Use the Aggregate Demand and Aggregate Supply model to show and explain how this statement might be true and which shock is assumed to be hitting the economy?

Answer 1

Demand Pull Inflation

When demand starts rising more than firms do the supply, economically due to demand and supply laws, firms respond by increasing the equilibrium prices. When rapid growth is experienced in the economy, firms tend to employ more, reducing unemployment. However, as unemployment has fallen, it becomes hard for firms to fill vacant positions; as a result, a labor shortage shock hits the economy, putting up wages. As wages increase, disposable income increases, further rising the aggregate demand. However, firm costs increase. Firms then pass these costs to consumers through a price level increase. Higher growth experienced in the economy translates to price rise expectations. These expectations become self-fulfilling, leading to a high inflation rate (Wollie, 2018).

Reference.

Wollie, G. (2018). The Relationship between Inflation and Economic Growth in Ethiopia. Budapest International Research and Critics Institute-Journal (BIRCI-Journal), 1(3), 264-271