INFLation - Practice Quiz

Cost-push inflation occurs when there is an increase in wages that surpasses the gains in productivity. This means that workers are demanding higher wages without a corresponding increase in their output or efficiency. As a result, businesses have to increase the prices of their products or services to cover the higher labor costs. This leads to an overall increase in the general price level, causing inflation.

When the economy is operating at its potential GDP, an increase in the money supply will lead to demand-pull inflation. This is because an increase in the money supply means that there is more money available in the economy for consumers to spend. As a result, the demand for goods and services increases, which leads to an increase in prices. This type of inflation is called demand-pull inflation because it is caused by an increase in demand exceeding the available supply.

If the government does not react to cost-push inflation with any policy actions, it is likely to lead to a recession. Cost-push inflation occurs when there is an increase in production costs, such as wages or raw materials, which leads to higher prices. If the government does not take any measures to address this inflationary pressure, it can result in a decrease in consumer spending and investment, leading to a decline in economic activity and ultimately a recession.

If there is demand-pull inflation in the economy, it means that aggregate demand (AD) increases, causing an increase in the price level (P) and real GDP (RDGP) in the short run. However, in the long run, the increase in AD will lead to higher prices, which will reduce the purchasing power of consumers and eventually decrease aggregate demand. As a result, the economy will return to its original equilibrium level of real GDP (Q1) but at a higher price level (P3). Therefore, the correct answer is P3 and RDGP will be Q1.

When there is demand-pull inflation in the economy, the aggregate demand (AD) curve shifts from AD1 to AD2. In the long run, the economy adjusts to this inflationary pressure, and the aggregate supply (AS) curve becomes perfectly vertical. This means that the economy's output is fixed at a specific level, represented by point Q1 on the AS curve. Therefore, the correct answer is "a vertical line at Q1".

Inflation refers to the increase in prices of goods and services over time. Economists generally agree that for sustained inflation to occur, the Federal Reserve must accommodate it by increasing the money supply. When the Federal Reserve increases the money supply, it puts more money into circulation, which can lead to an increase in spending and demand. This increase in demand can then drive up prices, causing inflation. Therefore, the correct answer is that the Federal Reserve must accommodate inflation by increasing the money supply.