Question

Discuss how the economy can have inflation from the demand side and from the supply side. Discuss the purpose of the Phillips curve and the shape of the Phillips curve in the long-run.

Answer 1

The inflation from the demand side is caused when the aggregate demand in the economy increases more than the supply in the economy. The increase in the aggregate causes an upward pressure in the price level that causes a high rate of inflation in the economy. It is the situation when there is a huge amount of money with the public, but the goods to be sold are limited, and demand is very high. Thus this cause inflation in the economy from the demand side.
The inflation from the supply side occurs when the cost of inputs and raw material increases because of scarcity. The rise in the cost of production leads to a decrease in the aggregate supply in the economy. The fall in aggregate supply also increase the price, and thus the inflation in the economy increases.
The purpose of the Phillips curve is to show the relationship between unemployment and inflation in the economy. Inflation and unemployment are inversely related to each other in the short run. The shape of the Phillips curve in the short run is L-shaped.
The shape of the Phillips curve in the long is vertical. The vertical Phillips curve indicates that the trade off between unemployment and inflation disappears.