Question

Q. What must happen to create a cost-push inflation spiral? How do real GDP and price level change if the forecast of inflation is incorrect?

Answer 1

Cost-push inflation occurs when prices pushed up due to increases in wages, raw materials, indirect taxes and other input factors (labor, capital, land or entrepreneurship). The rise in prices is due to increase in the costs to produce. When companies are running at full production capacity already, companies cannot maintain profit margin by producing the same amounts of goods and services. As a result, it ultimately passes along the increased price to consumers. Thus in an economy there must be a constant injection of money, in to the economy in order to compensate for the left shifting SAS curve

Cost-push inflation spiral is most likely to be associated with a negative GDP gap because the increasing production cost reduces spending and output. When the inflation forecast in inaccurate, real GDP may become higher compared to the potential GDP if the expected inflation is lower versus the actual rate, and when actual inflation rate is lower compared to expected then the real GDP falls