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Is it possible for there to be inflation present in the economy and still witness a...

Is it possible for there to be inflation present in the economy and still witness a decline in a large number of goods? If so, how and why is this possible?

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Answer #1


Ans. Yes, it is possible that the inflation is there in the economy but real output level falls i.e. decline in large number of goods.
This can happen if the economy is facing a negative supply side shock. For example, if the crude oil prices rise steeply. As crude oil is an important input to production in number of products, so, increase in crude price increases cost of production making production units to decrease production of goods which decreases aggregate supply of goods and services in the economy shifting aggregate supply curve leftwards from AS to AS'. This creates a shortage of good and services causing price level to rise from P to P' (thus, inflation) and real output to fall from Y to Y'.

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