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Figure 4.20c: The Mechanism of Profit-Push Inflation
Figure 4.20c illustrates the mechanism of profit-push inflation following a negative supply shock, such as an increased markup that allows firms to increase prices by an additional 2%. This shock shifts the Phillips curve vertically upward by 2%. Consequently, the economy moves from its initial equilibrium at point A (3% inflation) to point D, where inflation is 5% despite employment remaining constant at and expected inflation remaining at 3%. This jump in inflation is driven by the behavior of firms and workers. At point B, firms have raised prices by 5%, but workers were only expecting a 3% increase. This discrepancy creates a 2% reduction in the real wage, corresponding to the gap between the wage-setting curve and the new, lower price-setting curve at the initial employment level. The figure also shows the new supply-side equilibrium at point C, located on the new, higher Phillips curve, where inflation would stabilize if employment were to fall to the new equilibrium level.
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Ch.4 Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
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Figure 4.25: Price Responses to Rising Employment and Capacity Utilization
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In a scenario of profit-push inflation, where firms increase their price markups due to a decrease in market competition, the price-setting (PS) curve shifts upward, creating a positive bargaining gap that drives inflation.
Match each component of the profit-push inflation model with its corresponding role or outcome in the economic process.
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When firms with increased market power decide to raise their profit margins, the price-setting curve shifts ______, which creates a bargaining gap and initiates an inflationary spiral at the existing level of employment.
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Consider an economy where several key industries become more concentrated, leading to reduced competition. Firms in these industries subsequently raise their prices, even though their costs for labor and materials have not changed. Within the standard wage-setting and price-setting framework, what is the direct mechanism that initiates the resulting inflation?
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Figure 4.20c: The Mechanism of Profit-Push Inflation
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Figure 4.26: Profit-Push Inflation Due to Capacity Constraints
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