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Explain and use an AS/AD diagram to illustrate the long run effects of expected demand -...

Explain and use an AS/AD diagram to illustrate the long run effects of expected demand - pull inflation.

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Answer #1

An increase in the expected inflation will increase the demand in the short run and actually increase the demand and price thereby shifting the AD curve to the right. The new output will be Y and price will be P*,

In the long run, it will lead to a higher wages and act as a negative supply shock in the market. It will shift the aggregate supply curve to the left and increase the price further the new output in the long run will be same as the potential output and the equilibrium will be at C.

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