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If aggregate demand (AD) rises faster than productive capacity (LRAS), then
firms will respond by putting up prices, creating inflation.
Excess demand and ‘too much money chasing too few goods.’
The economy is at (or ver close to) full employment/full capacity.
The economy will be growing at a rate faster than the long-run trend rate.
A falling unemployment rate.
How demand-pull inflation occurs
If aggregate demand is rising at 4%, but productive capacity is only rising at
2.5%; firms will see demand outstripping supply. Therefore, they respond by
increasing prices.
Also, as firms produce more, they employ more workers, creating a rise in
employment and fall in unemployment. This increased demand for workers puts
upward pressure on wages, leading to wage-push inflation. Higher wages
increase the disposable income of workers leading to a rise in consumer
spending.
The long trend rate of economic is the sustainable rate of economic growth; it is
the rate of economic without any demand-pull inflation. If economic growth
exceeds this long-run trend rate, then it will cause inflationary pressures.
In a boom, growth is above the long-run trend rate, and it is in this situation
where we will get demand-pull inflation.
The inflation of the late 1970s was due primarily to cost-push factors (wages/oil
prices of 1970s)
UK 1980s-91
Th
e quarterly growth rate in the UK.
During the late 1980s, the rate of economic growth in the UK rose to over 4%.
The high rate of economic growth was caused by demand-side factors, such as:
US late 1960s
US Inflation: St Louis Fed
Rapid economic growth in the mid-1960s, caused inflation to increase from 2% in
1966 to 6% by 1970.