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Now, it should clear from looking at this flat portion of the curve,
the government can implement expansionary, fiscal, or
monetary policy to stimulate growth, with little fear of inflation.
Note, for example, that an increase in aggregate demand triggered by
expansionary government policies shifts output from Q1 to Q2.
But the price level remains the same.
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Now in contrast, in the vertical or classical range,
the economy has reached its full capacity level of real output at Q sub c.
In this range, any attempt to increase production further through a Keynesian
fiscal or monetary stimulus will not substantially increase real output but
merely lead to inflation.
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For example, you can see very clearly here that an increase in aggregate demand,
AD5 to AD6, does not increase Q sub c.
Instead, price level rises, P5 to P6.
And here's the key point, in this classical range,
expansionary fiscal and monetary policies will not be effective at all.
In fact any form of Keynesian stimulus, if it is tried,
the only result will be inflation, not an increase in GDP growth.
This is textbook demand-pull inflation because it is precisely outward
shifts in aggregate demand that are pulling up the price level.
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Let's look more closely now at the intermediate range of the economy
between Q sub u and Q sub c.
In this intermediate range,
any expansion of real output is also accompanied by a rise in price level.
And in this intermediate range scenario, policymakers always
face a tradeoff between seeking to stimulate more GDP growth,
a good thing, versus stimulating more inflation.
Which is usually a bad thing.
In fact, this intermediate range is much more typical of real world conditions.
The underlying problem is that the economy is comprised of the numerable product and
resource markets.
And as the business cycle moves from recession to expansion, and
from employment, movements in all these markets may not occur simultaneously.
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However, the high tech computer and
software industries may begin to experience shortages in skilled workers.
At the same time, raw material shortages or
bottle necks in production may begin to appear in other industries.
Thus, even though there may be some recessionary slack in parts of
the economy, in other parts conditions may be conducive to cause an inflation.
[SOUND] This situation Is illustrated in this portion of our figure.
Here, real GDP begins with Q sub 3, but
it is below the full employment output, Q sub 4.
In this case, stimulating aggregate demand through expansionary physical or
monetary policy will indeed move the economy to Q sub 4.
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In the real world, fixing the problems of recession and
inflation are actually highly interrelated.
With that observation, let's move on to our next and last module of this lesson.
In which we will take a fun look at various strategies both business
executives and investors can use to hedge against the negative effects of inflation.
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When you're ready, let's move on.
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Dr. Peter NavarroProfessor
