Based on the scenario described, explain the immediate mechanism that will likely lead to upward pressure on prices and wages in this economy.

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The process of inflation in a business cycle upswing begins when the economy is at its supply-side equilibrium, characterized by stable prices and wages (zero inflation). An increase in aggregate demand disrupts this balance by causing unemployment to fall below the equilibrium level. This shift creates the initial conditions for upward pressure on wages and prices.

Aggregate Demand Shock as an Inflationary Trigger

Consider an economy initially in a state of equilibrium with stable prices and a constant rate of unemployment. If there is a sudden and significant increase in overall spending, which of the following sequences best describes the initial process that leads to inflation?

Analyzing an Economic Upswing

Imagine an economy is operating at a stable equilibrium where prices and wages are not changing. Explain the step-by-step process through which a sudden, large increase in overall spending would lead to the beginning of inflation. In your explanation, be sure to describe the immediate effect on the labor market and how that effect translates into pressure on wages and then prices.

The Onset of Inflation from a Demand Shock

An economy is initially in a state of equilibrium with stable prices and wages. A positive shock to aggregate demand occurs. Arrange the following events in the chronological order they would happen, starting from the initial impact of the shock.

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