Question

Use a supply and demand diagram to illustrate: a. Cost-push inflation caused by a labor union successfully negotiating for a higher wage. b. Demand-pull inflation caused by an increase in demand for domestic products from foreign buyers.

Short answer

Question: Explain how a labor union's successful negotiation of higher wages can result in cost-push inflation and how an increase in demand for domestic products by foreign buyers can result in demand-pull inflation. Answer: When labor unions negotiate for higher wages, it causes an increase in production costs for firms. This results in a leftward shift in the supply curve, leading to a new equilibrium with higher price levels, illustrating cost-push inflation. On the other hand, when there is an increase in demand for domestic products from foreign buyers, the demand curve shifts to the right and intersects with the supply curve at a higher price level, resulting in demand-pull inflation.

Step-by-step solution

Draw the initial supply and demand curves

Start by drawing a simple supply and demand diagram with the price (P) on the vertical axis, and quantity (Q) on the horizontal axis. Label the initial equilibrium where the supply curve (S1) intersects the demand curve (D) as point A.

Show the increase in labor costs

Since labor unions have negotiated for higher wages, this will result in increased production costs for firms. As such, they will be less willing to supply goods and services at the previous price levels. This will cause the supply curve to shift to the left. Draw a new supply curve (S2) to the left of the initial supply curve (S1) to illustrate this.

Identify the new equilibrium

After the shift in the supply curve, the new equilibrium occurs where the new supply curve (S2) intersects the demand curve (D). Label this point as B.

Illustrate the cost-push inflation

Since the new supply curve intersects at a higher level on the price axis, draw an arrow pointing upwards from the original price to the new price (P1 to P2) to illustrate the increased price level due to cost-push inflation. #b. Demand-Pull Inflation#

Draw the initial supply and demand curves

Similar to part a, start by drawing a simple supply and demand diagram with the price (P) on the vertical axis and quantity (Q) on the horizontal axis. Label the initial equilibrium where the supply curve (S) intersects the demand curve (D1) as point A.

Show the increase in demand from foreign buyers

Since there is an increase in demand for domestic products from foreign buyers, this will cause the demand curve to shift to the right. Draw a new demand curve (D2) to the right of the initial demand curve (D1) to illustrate this.

Identify the new equilibrium

The new equilibrium occurs where the new demand curve (D2) intersects the supply curve (S). Label this point as B.

Illustrate the demand-pull inflation

Since the new demand curve intersects at a higher level on the price axis, draw an arrow pointing upwards from the original price to the new price (P1 to P2) to illustrate the increased price level due to demand-pull inflation.

Key concepts

Supply and Demand

The concepts of supply and demand are fundamental in understanding economics. These two forces determine how much of a product is produced and consumed in a market. If we think of a market as a busy street, demand would be the people wanting balloons and supply would be the vendors selling them.

Demand refers to how much of a product consumers are willing to buy at different prices. It is represented by a downward-sloping curve, meaning as prices drop, consumers are more eager to purchase. On the other hand, supply shows how much of a product sellers are willing to provide at varying price points. This is the upward sloping line, meaning as prices increase, vendors are more willing to sell their products.

When supply and demand meet, it's called the equilibrium. This point shows the price at which the quantity supplied equals the quantity demanded. But, when there's any change in costs like wages or an increase in customer interest, these curves shift, causing changes in prices and quantities sold.

Cost-Push Inflation

Cost-push inflation happens when the costs of production rise, and companies pass these costs onto consumers in the form of higher prices. Let's say a labor union successfully negotiates a wage increase for workers. This increase means higher costs for the companies to produce goods and services.

In a supply and demand model, this situation causes the supply curve to shift to the left, representing less willingness by businesses to supply at previous prices. As a result, the new equilibrium point shows a higher price level, signifying inflation.

Some key points about cost-push inflation include:

• Originates from increased production costs.
• Often leads to a decrease in production.
• Can be caused by factors like higher wages or more expensive raw materials.

Demand-Pull Inflation

Demand-pull inflation occurs when there is high consumer demand, and companies must increase production efforts to meet that demand. Imagine if international buyers suddenly wanted more domestic products. This new demand would push businesses to raise prices.

In terms of supply and demand, the demand curve shifts to the right. This means an increase in the amount that consumers wish to buy at every price level, leading to new equilibrium at a higher price.

Highlights of demand-pull inflation include:

• Triggered by rising consumer demand.
• Causes a shift in power where sellers can charge more as consumers compete for limited stock.
• Can be sparked by various factors like economic growth or increased buying capacity of consumers.