Sep 24 2007

IB Review – Neo-classical vs. Keynesian views of inflation

Theory 1 – Demand-pull inflation – is inflation demanding?

The Keynesian view of Demand Pull inflation: Notice the large horizontal section of the AS curve. This represents the wage inflexibility and the elasticity of supply at high levels of unemployment. In a recession, large number of workers are unemployed, so any increase in price will result in a large increase in output, since firms can easily attract new workers without increasing wages. So what about the upward sloping and vertical sections? These of course represent the full-employment level (upsloping) and beyond full employment to full-capacity production, when any increase in aggregate demand is “absorbed” by price level increases with no further increase in output, since all resources are being used to their full-capacity, and even further increases in wages will not increase national output.


Classical view of Demand-pull inflation and the “self-correction” that occurs: In the classical model, the LRAS is perfectly inelastic at the full-employment level of output. This is because classical economists believe in perfect wage and price flexibility. The outward shift of AD will result in no increase in output since the higher price level will quickly result in higher wages, which since wages are a resource cost, shifts AS leftward resorting full-employment output at a new, higher price level.

Classical view of D pull inflation and self-correction

Theory 2 – Cost-push inflation – is inflation pushy?

Cost-push inflation: Due to an increase in resource costs, AS shifts inward, “pushing” prices up with it.

Cost-push inflation - supply shocks

Talk to a Classical economist, and they will advise

‘Don’t just do something, sit there!’

while a Keynesian will advise

‘Don’t just sit there, do something!’

Can you explain this saying? If so, you’ve probably got Keynesian and Classical views pretty well figured out.

2 responses so far

2 Responses to “IB Review – Neo-classical vs. Keynesian views of inflation”

  1. tangon 10 Jul 2008 at 5:40 pm

    a questions need you help

  2. Jackon 31 May 2010 at 1:36 am

    If this is an IB review, are you not forgetting inflation due to excess monetary growth?

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