indian economic environment 6. the economy & business activity
TRANSCRIPT
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6The Economy and
Business Activity
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Macroeconomic Objectives
• Microeconomics and macroeconomics
• The major macroeconomic issues– economic growth
– unemployment
– inflation
– balance of payments and exchange rates
• Government macroeconomic policy– controlling various intermediate variables
• interest rates, money supply, taxes, government expenditure, etc.
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The Circular Flow of Income
• The inner flow
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Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
The circular flow of income
Firms
Households
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The Circular Flow of Income
• Withdrawals
– net saving (S)
– net taxes (T)
– import expenditure (M)
• Injections
– investment (I)
– government expenditure (G)
– export expenditure (X)
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Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Investment (I)
Governmentexpenditure (G)
Exportexpenditure (X)
BANKS, etc
Netsaving (S)
GOV.
Nettaxes (T)
ABROAD
Importexpenditure (M)
The circular flow of income
WITHDRAWALS
INJECTIONS
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The Circular Flow of Income
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
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Factorpayments
Consumption ofdomestically
produced goodsand services (Cd)
Investment (I)
Governmentexpenditure (G)
Exportexpenditure (X)
BANKS, etc
Netsaving (S)
GOV.
Nettaxes (T)
ABROAD
Importexpenditure (M)
The circular flow of income
WITHDRAWALS
INJECTIONS
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The Circular Flow of Income
• The relationship between withdrawals and injections
– the links between them
– planned injections may not equal planned withdrawals
• effect of J > W
• effect of W > J
– equilibrium in the circular flow
• The circular flow and the four macroeconomic objectives
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The Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
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45°
O GDP (£bn)
GDP = Cd + W
Cd, E, W, J (£bn)
Equilibrium GDP
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The Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
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45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
JJ
Equilibrium GDP
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The Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of E > GDP
• effects of GDP > E
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45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
GDP1 GDP2
a
b
c
d
Equilibrium GDP
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The Determination of Business Activity
• The importance of aggregate demand
– effects of J > W
– effects of W > J
• Identifying the equilibrium level of GDP
– the 45o line diagram
– the GDP and E lines
• effects of GDP > E
• effects of E > GDP
– finding the equilibrium point
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45°
O GDP (£bn)
GDP = Cd + W
E = Cd + J
Cd, E, W, J (£bn)
Cd
GDP1 GDP2GDPe
a
b
c
de
Equilibrium GDP
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The Determination of Business Activity
• The multiplier
– the multiplier process
– definition of the multiplier∀∆GDP / ∆J
– the marginal propensity to consume domestic goods and services
• mpcd = ∆Cd / ∆GDP
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GDP
E1
O GDP (£bn)100
E2
160
Multiplier = ∆GDP / ∆ J= 60/20 = 3
100
120
160
Cd, E, W, J (£bn)
The multiplier: a rise in aggregate expenditure
Cd
∆ J
∆Cd = 40
∆GDP = 60
∆GDP
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The Determination of Business Activity
• The multiplier
– the multiplier process
– definition of the multiplier∀∆GDP / ∆J
– the marginal propensity to consume domestic goods and services
• mpcd = ∆Cd / ∆GDP
– formula for the multiplier• 1 / (1–mpcd)
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GDP
E1
O GDP (£bn)100
E2
160
Multiplier = ∆GDP / ∆ E= 60/20 = 3
100
120
160
Cd, E, W, J (£bn)
Cd
∆ J
∆Cd = 40
∆GDP = 60
∆GDP
The multiplier: a rise in aggregate expenditure
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The Business Cycle
• Growth in actual and potential output
• Economic growth & the business cycle
– fluctuations in actual growth
– the phases of the business cycle
• the upturn
• the expansion
• the peaking out
• the slowdown or recession
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O
Nat
iona
l out
put
Time
Potential output
1
2
3
4
1
2
34Actualoutput
The business cycle
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The Business Cycle
• Growth in actual and potential output
• Economic growth & the business cycle– fluctuations in actual growth
– the phases of the business cycle• the upturn
• the expansion
• the peaking out
• the slowdown or recession
– long-term output trend
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O
Nat
iona
l out
put
Time
Potential output
Actualoutput
Trendoutput
The business cycle
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The Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
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The Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases
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The Business Cycle
• Growth in actual and potential output• Economic growth & the business cycle
– fluctuations in actual growth– the phases of the business cycle
• the upturn• the expansion• the peaking out• the slowdown or recession
– long-term output trend– the business cycle in practice
• the length of the phases• the magnitude of the phases
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An
nual
gro
wth
rat
e (
%)
UK
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
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An
nual
gro
wth
rat
e (
%)
UK
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
USA
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15
USA
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15 Japan
USA
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An
nual
gro
wth
rat
e (
%)
Growth rates in selected industrial countries
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
1970 1975 1980 1985 1990 1995 2000 2005
UK
EU15 Japan
USA
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The Business Cycle
• Causes of cyclical fluctuations– Why does AD change in the first place?– Why do booms and recessions persist?
• time lags• bandwagon effects
– the accelerator
– Why do booms and recessions end?• ceilings and floors• echo effects• the accelerator• random shocks• changes in government policy
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Money, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
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Credit creation: Banks' original balance sheet
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Credit creation: Effect of a new deposit of £10bn
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Credit creation: Full effect of a new deposit of £10bn
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Money, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
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Money, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world
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Money, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
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Money, Interest Rates and Business Activity
• The meaning of money– narrow definitions of money (M0 in the UK)
– broad definitions of money (M4 in the UK)
• The supply of money– banks and the creation of credit
• simple illustration
• the deposits multiplier
– creation of credit: the real world• banks' liquidity ratio may vary
• banks respond to the demand for money
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• Causes of increases in money supply
– increased demand for money
• banks reduce liquidity ratio
– inflow of funds from abroad
– a public-sector deficit (PSNCR)
• depends on how it is financed
– from banking sector: money supply expands
– from outside the banking sector: money supply does not expand
Money, Interest Rates and Business Activity
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• The demand for money
– reasons for holding money
• transactions and precautionary motive
• assets or speculative motive
– determinants of demand for money
• money national income
• speculation about future return on assets
• rate of interest
Money, Interest Rates and Business Activity
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• Equilibrium rate of interest
– where demand for money equals supply
Money, Interest Rates and Business Activity
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OMoney
Ra
te o
f in
tere
st
Md
re
Equilibrium in the money market
MS
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• Equilibrium rate of interest
– where demand for money equals supply
– if supply of money rises or demand for money falls, the rate of interest will fall
Money, Interest Rates and Business Activity
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OMoney
Ra
te o
f in
tere
st
Md
re
Equilibrium in the money market
MS
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• Effects of changes in money supply on national income
– rise in money supply causes interest rate to fall
– fall in interest rate causes investment to rise
– rise in investment causes GDP to rise
• Determinants of the size of these effects
Money, Interest Rates and Business Activity
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Unemployment
• Measuring unemployment
– defining the unemployment rate
– claimant unemployment
• do claimant statistics give a true picture of unemployment?
– standardised unemployment (ILO/OECD)
• use of labour force surveys
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
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Aggregate demand and supply of labour
O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
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QeO
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
We
Aggregate demand and supply of labour
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
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O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
We
W2
Disequilibrium unemployment
Q2 Q1
B A
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
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Equilibrium unemployment
O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ADL
We
ASL
e
Qe
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Q2QeO
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
We
N
e d
Equilibrium unemployment
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Equilibrium and disequilibrium unemployment
O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ADL
We
e
Qe
ASL
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O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
We
W2
b a
e
Disequilibriumunemployment
Equilibrium and disequilibrium unemployment
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O
Ave
rage
(re
al)
wa
ge r
ate
No. of workers
ASL
ADL
We
W2
b a
e
N
c
Equilibriumunemployment
Disequilibriumunemployment
Equilibrium and disequilibrium unemployment
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
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Unemployment
• Unemployment and the labour market
– the aggregate demand and supply of labour
• equilibrium in the model
– disequilibrium unemployment
– equilibrium unemployment
• Disequilibrium unemployment
– real-wage unemployment
– demand-deficient (cyclical) unemployment
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An
nual
gro
wth
rat
e (
%)
UK
Unemployment rates in selected industrial countries
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
![Page 70: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/70.jpg)
An
nual
gro
wth
rat
e (
%)
UK
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
Unemployment rates in selected industrial countries
![Page 71: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/71.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
Unemployment rates in selected industrial countries
![Page 72: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/72.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
Unemployment rates in selected industrial countries
![Page 73: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/73.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
USA
Unemployment rates in selected industrial countries
![Page 74: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/74.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
USA
Unemployment rates in selected industrial countries
![Page 75: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/75.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15 Japan
USA
Unemployment rates in selected industrial countries
![Page 76: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/76.jpg)
0
2
4
6
8
10
12
14
1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15 Japan
USA
Unemployment rates in selected industrial countries
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Unemployment
• Equilibrium unemployment
– frictional (search) unemployment
– structural unemployment
• changing pattern of demand
• technological unemployment
• regional unemployment
– seasonal unemployment
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Inflation
• Defining inflation
– consumer price inflation
– other categories of inflation
• Inflation in historical perspective
– low inflation in 1950s and 60s
– high inflation in 1970s and 80s
– low inflation since mid 1990s• most developed countries gear monetary policy
to achieving a low target rate of inflation
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An
nual
gro
wth
rat
e (
%)
UK
Inflation rates in selected industrial countries
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
![Page 80: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/80.jpg)
An
nual
gro
wth
rat
e (
%)
UK
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
Inflation rates in selected industrial countries
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-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
Inflation rates in selected industrial countries
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-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
Inflation rates in selected industrial countries
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-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
USA
Inflation rates in selected industrial countries
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-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15
USA
Inflation rates in selected industrial countries
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-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15 Japan
USA
Inflation rates in selected industrial countries
![Page 86: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/86.jpg)
-2
0
2
4
6
8
10
12
14
16
18
20
22
24
26
1965 1970 1975 1980 1985 1990 1995 2000 2005
An
nual
gro
wth
rat
e (
%)
UK
EU15 Japan
USA
Inflation rates in selected industrial countries
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve
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O
Pri
ce le
vel
National output
AD
Aggregate demand and aggregate supply
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve
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O
Pri
ce le
vel
National output
AS
AD
Aggregate demand and aggregate supply
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve• why AS curves generally slope upwards
![Page 94: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/94.jpg)
Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve• why AS curves generally slope upwards
– equilibrium
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O
Pri
ce le
vel
National output
AS
AD
Pe
Aggregate demand and aggregate supply
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O
Pri
ce le
vel
National output
AS
AD
Pe
P2
ab
Aggregate demand and aggregate supply
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Inflation
• Aggregate demand & supply and prices
– aggregate demand curve• why AD curves slope downwards
– lower price level leads to fewer imports
– lower price level tends to cause interest rates to fall
– lower price level increases value of people's savings
– aggregate supply curve• why AS curves generally slope upwards
– equilibrium
– shifts in AD and AS curves
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Inflation
• Causes of inflation– demand pull
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Demand-pull inflation
O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
![Page 100: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/100.jpg)
O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
AD2
Demand-pull inflation
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O
Pri
ce le
vel
National output
AS
AD1
P1
Q1
AD2
P2
Q2
Demand-pull inflation
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Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
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Cost-push inflation
O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
![Page 104: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/104.jpg)
O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
AS2
Cost-push inflation
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O
Pri
ce le
vel
National output
AS1
AD
P1
Q1
AS2
P2
Q2
Cost-push inflation
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Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– the interaction of demand-pull and cost-push inflation
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The interaction of demand-pull and cost-push inflation
O
Pri
ce le
vel
National output
AS1
AD1
P1
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O
Pri
ce le
vel
National output
AS1
AD1
P1
AS2
AD2
P2
The interaction of demand-pull and cost-push inflation
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O
Pri
ce le
vel
National output
AS1
AD1
P1
AD2
P2
AS3
AD3
P3
AS2
The interaction of demand-pull and cost-push inflation
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Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
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Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation
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Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
![Page 113: Indian economic environment 6. the economy & business activity](https://reader034.vdocuments.us/reader034/viewer/2022042701/55a67d121a28ab6c6f8b459b/html5/thumbnails/113.jpg)
Inflation
• Causes of inflation– demand pull
– cost push• wage push
• profit push
• import-price push
– expectations and inflation
• Policies to tackle inflation– demand-side policies
– supply-side policies