Inflation plays a big role in how our economy works. It affects both how much people want to buy (aggregate demand) and how much businesses can supply (aggregate supply). Here’s how it happens:
Impact on Aggregate Demand:
Consumer Spending: When inflation goes up, people can buy less with their money. This means if wages don’t increase, folks will start spending less because prices are higher. As a result, aggregate demand can go down.
Interest Rates: To fight high inflation, central banks often raise interest rates. This makes it more expensive to borrow money. When borrowing costs more, businesses invest less, and people buy fewer expensive things. This leads to aggregate demand dropping.
Impact on Aggregate Supply:
Production Costs: If inflation is caused by higher prices for raw materials, it costs businesses more to produce their products. Because of this, they might make less or charge more, which can push aggregate supply down.
Wage-Price Spiral: As prices increase, workers often want higher wages to cover their living expenses. If businesses give in and raise wages, this can lead to even more inflation, which hurts both aggregate supply and demand.
In short, inflation can slow down how fast the economy grows. It can make people less confident and change how they spend their money. This can create a cycle where businesses change what they supply and their prices because of inflation. That’s why paying attention to inflation is really important for understanding our economy!
Inflation plays a big role in how our economy works. It affects both how much people want to buy (aggregate demand) and how much businesses can supply (aggregate supply). Here’s how it happens:
Impact on Aggregate Demand:
Consumer Spending: When inflation goes up, people can buy less with their money. This means if wages don’t increase, folks will start spending less because prices are higher. As a result, aggregate demand can go down.
Interest Rates: To fight high inflation, central banks often raise interest rates. This makes it more expensive to borrow money. When borrowing costs more, businesses invest less, and people buy fewer expensive things. This leads to aggregate demand dropping.
Impact on Aggregate Supply:
Production Costs: If inflation is caused by higher prices for raw materials, it costs businesses more to produce their products. Because of this, they might make less or charge more, which can push aggregate supply down.
Wage-Price Spiral: As prices increase, workers often want higher wages to cover their living expenses. If businesses give in and raise wages, this can lead to even more inflation, which hurts both aggregate supply and demand.
In short, inflation can slow down how fast the economy grows. It can make people less confident and change how they spend their money. This can create a cycle where businesses change what they supply and their prices because of inflation. That’s why paying attention to inflation is really important for understanding our economy!