Assume that, after analyzing its business transaction, a firm has the following ending balances: accounts payable $3,400, accoun
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When the firms recover from the flood and business start to operate again, the short-run aggregate supply curve will <u>shift to othe left to SRAS2 (B)</u> because the firms need more capitals to start producing then raise the product price. After this last shift in the aggregate supply curve, the economy will be at <u>Point B (B)</u> because the aggregate demand remains and people tend to buy fewer units of product. Finally, also suppose that people expect that there will be a huge rebuilding effort. Based on this expectation, the aggregate demand curve will <u>shift to the right to AD2 (B). </u>Because of aggregate demand's response to the expected rebuilding effort, the economy will be at <u>point D (D)</u> where the real GDP remains but inflation takes place.
To understand this case better, please take a look at the graph below.
We assume that the original position of the short-run aggregate supply is SRAS1.
When the firms recover from the flood and start to operate again, they need more capitals to produce their products. They need more capitals and investments to operate their manufacturing again. These investment and capitals could be used to reparation their machines and repurchasing new raw materials. Align with increase in costs, the firms need to raise the product price to gain some profits. Hence, the short-run aggregate supply will shift to the left and move to SRAS2 position.
Without any intervention, the new equilibrium will move to the point B where people will buy fewer units of product at the same original price. People will reject to spend more money to buy the same amount of products as before flood happens.
The government then will make public rebuilding investments and give hopes to people. People who are now expecting a huge rebuilding effort become confidence to spend more money on purchasing the products. This condition will shift the aggregate demand curve to the right.
Because of this movement, the new equilibrium will be made. This new equilibrium will be in the long-run aggregate supply (LRAS) curve but with higher vertical position. This new equilibrium shows that the real GDP will remain the same, but there will be increase in prices or inflation.
This scenario demonstrates an inflation scenario called Cost-Pushed Inflation. Cost-Pushed Inflation happens when SRAS shifts when there is an increase in production costs or products prices. AD then will shifts because of government's policy to inject money through public investment.
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