Why is full employment necessary for demand pull inflation?

1 Answer
Nov 1, 2015

Till full employment is reached, additional investment leads to creation of new jobs and increase in output. It has no effect on the price.


According to Keynes the aggregate supply curve is horizontal and parallel to x-axis.

So long the economy is travelling along this supply curve, additional investment will create new jobs and increase output. It has no effect on the price. Once full employment is reached, the aggregate supply curve becomes vertical. There is no more resources to be exploited by new investments. Hence additional investment only increases the price and that is inflation.

The horizontal part of the aggregate demand curve is called Keynesian range. The vertical part of the demand curve is called classical range. In between these two ranges there is intermediate range in which the AD curve slopes upward. In this range a part of the additional investment goes to increase the output and a part is reflected as increase in price by strengthening the Aggregate Demand.

So For inflation to occur in an economy full employment is necessary.

In this video Keynesian range is not given.

Demand Pull Inflation