Using the Expenditure Model (GDP = C + G + I + NX), draw a graph...

Using the Expenditure Model (GDP = C + G + I + NX), draw a graph that depicts Demand-Pull inflation.

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Expert Solution

The graph would be as below.

For the GDP be , we have the representative AD and AS curve, and the initial equilibrium at X. Now, in case of demand pull inflation, the AD increases to AD' due to increase in consumption and/or government spending and/or NX, ie for , the representative AD is AD'. The new equilibrium would be at Y, at where the price have increased.

Hence, inflation in case of demand pull inflation would happen in framework of expenditure model when

C : consumer expenditure increases for some reason, such as increase in price of a group of products (which may happen as a significant factor like oil prices spikes up).
G : government spending increases as a part of expansionary fiscal policy.
NX : domestic currency depreciates and that change in exchange rate causes export to increase, ie net export increases.

Rahul Sunny answered 4 weeks ago

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