Macro Foundations · advanced
What moves on the Aggregate Supply – Aggregate Demand diagram
Expected inflationinflationA sustained rise in the overall price level, eroding money's purchasing power. feeds directly into wage- and price-setting, raising costs and shifting SRASSRASShort-run aggregate supply: what firms produce at each price level while wages and input costs are still sticky. left even without any realrealAdjusted for inflation, measured in actual purchasing power. shock.
Start at equilibriumequilibriumThe point where opposing forces balance, quantity supplied equals quantity demanded, so there's no pressure for price to change..
Workers and firms come to expect higher future inflationinflationA sustained rise in the overall price level, eroding money's purchasing power..
Wage demands and price-setting rise pre-emptively, unit costs rise, SRASSRASShort-run aggregate supply: what firms produce at each price level while wages and input costs are still sticky. shifts left.
New equilibriumequilibriumThe point where opposing forces balance, quantity supplied equals quantity demanded, so there's no pressure for price to change.: prices rise and output dips, expectationsexpectationsBeliefs about the future that shape behavior today, the hinge variable of modern macroeconomics. alone moved the economy.
If expectationsexpectationsBeliefs about the future that shape behavior today, the hinge variable of modern macroeconomics. keep ratcheting, the shift repeats: the wage-price spiral. This is why central banks defend 'anchored' expectations.
Examiners ask this as: inflation expectations, wage price spiral, workers demand raises, expected inflation rises, de-anchored expectations.
Other scenarios on Aggregate Supply – Aggregate Demand