Graphically, demand-pull inflation is shown as a:
a. rightward shift of the AD curve along an upsloping AS curve.
b. leftward shift of the AS curve along a down-sloping AD curve.
c. leftward shift of AS curve along an upsloping AD curve.
d. rightward shift of the AD curve along a down-sloping AS curve.
The correct answer and explanation is :
Correct Answer:
a. Rightward shift of the AD curve along an upsloping AS curve.
Explanation:
Demand-pull inflation occurs when aggregate demand (AD) in an economy exceeds aggregate supply (AS), leading to a general rise in the price level. This type of inflation is typically driven by factors such as increased consumer spending, government expenditure, investment by businesses, or expansionary monetary and fiscal policies.
Graphically, demand-pull inflation is illustrated as a rightward shift of the AD curve along an upward-sloping AS curve. Here’s how it works:
- Aggregate Demand (AD) Increases
- When households, businesses, or the government increase their spending, the overall demand for goods and services rises.
- This increase in demand shifts the AD curve to the right (from AD1 to AD2).
- Interaction with Aggregate Supply (AS)
- The AS curve is typically upward-sloping in the short run because, as demand increases, firms respond by increasing production.
- However, as firms produce more, they face rising costs (e.g., higher wages, raw material costs), leading to higher overall prices.
- Price Level Rises
- The economy moves from an initial equilibrium point (E1) to a new equilibrium (E2) at a higher price level.
- This results in inflation, as goods and services become more expensive.
Why the Other Options Are Incorrect:
- Option (b) suggests a leftward shift of AS, which represents cost-push inflation, not demand-pull inflation.
- Option (c) is incorrect because a leftward shift in AS would indicate supply-side constraints, not increased demand.
- Option (d) is incorrect because the AS curve is not downward-sloping; it typically slopes upward in the short run.
Thus, demand-pull inflation is best represented by a rightward shift of the AD curve along an upsloping AS curve.