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.