Question

2. Macroeconomic Policy & Price Adjustment Curves: Suppose that the economy is initially at potential output. What are the short-run and the long-run responses of the inflation rate and the output gap if the expected inflation rate rises? Use a macroeconomic policy curve and price adjustment curve graph to support your answer.

Answer 1

The measure of percentage of the rise in the cost of living is referred to as inflation. Inflation increase directly means that the prices are rising at a rate which is above normal. During inflation , the cost of raw materials increase. In the short term, there are many consequences of inflation. The workers start demanding higher wages to meet their daily living standard requirements. It makes the market uncertain and volatile. The firms stop making decisions on their future investment as they are not sure about the future costs they would incur in producing a certain quantity of their product. They want inflation to be under control , which makes it easier for them to take future decisions .Moreover, they hold back their investment because, with the inflation on the rise, the interest prevailing in the market would rise substantially , which will directly affect their cost of the production of the quantities of products.The people would want to buy off their necessity products early and before time , in the assumption that prices would further rise in the future. This is also a situation , where no one is aware as to what is the best price of a product ,and when is the best time to buy it , which will result in a scenario of chaos in the market. The consumers would further loose more of their wealth wondering around searching for the best product. However in the longer run , the picture tends to get clearer and people start buying the product at the best price.When inflation rises rapidly, the banks would want to raise the interest rates. His will increase the borrowing cost of the investors and the producers and would directly result in more inflator prices of the products.This is result in a negative affect on the economic growth of the society and hinder development. This will further result in lower demand from the consumers, and the prices would tend to follow the inflation of demand-pull.

The lenders of money would start facing lower rate of their profits as the interest rate would rise and the value of their saved money would fall.The cost of living would be raised by the inflation. The wages that the workers get, would start to be lesser in value that the value of that wage that prevailed earlier. The firms may raise wages for a temporary period to support their workers, but this would only be a temporary fix, and in the longer run the firms would want to get rid of some of the workers, to save their money and want to produce more with lesser workers on board, which would mean more pressure on the existing set of workers.Inflation results in an uncertain economic growth. At times, it is seen that a rapid rate of economic growth result in inflation. However, in the longer run , such an economic growth will not be a sustainable growth, more so , if there is an increase in the rate of interest. Therefore, at times , a higher inflation may be considered a pre-period before an approaching economic crisis. However, at times low rate of economic growth may also impact to inflation , as due to low profits, the local producers may tend to increase the prices of their products to earn more from less sales. This in the longer run leads to inflation.