Question

The AD/AS model is static. It shows a snapshot of the economy at a given point in time. Both economic growth and inflation are dynamic phenomena. Suppose economic growth is 3% per year and aggregate demand is growing at the same rate. What does the AD/AS model say the inflation rate should be?

Short answer

Economic growth is a positive indication since it means the economy is heading in the right direction.

Step-by-step solution

Step1. Introduction

Inflation is a quantitative economic measure of the rate of change in the prices of particular commodities and services over time.

Step2. Explanation

Since this economy is increasing at 3% per year, demand for products and services will rise. Economic growth is a positive indication since it means the economy is heading in the right direction.

Assuming that aggregate supply remains constant, a rise in AD will only result in a price increase, resulting in inflation. As supply will be restricted and demand will rise, the price level will only rise, resulting in inflation.