An increase in the rate of expected inflation causes _____.

An increase in the rate of expected inflation causes _____.

a. the short-run aggregate supply curve to shift down

b. an upward movement along the short-run aggregate supply curve

c. the short-run aggregate supply curve to shift up

d. a downward movement along the short-run aggregate supply curve

Answer: c. the short-run aggregate supply curve to shift up

The inability to feel the adverse impact of an increase in the rate of expectational inflation leads to an upward shift of the short-run aggregate supply curve. The short run aggregate supply curve typically illustrates the change in the quantity of real GDP supplied in response to changes in the price level when some of the factors of production such as capital, labour etc. remain fixed. This is an expectation of a price level increase in the future hence cost of inputs which includes wages as well as raw materials is expected to increase in the future. It is for this reason that they ask for better price settings for their products so that they can cover their costs of operation fully. The effect of this increase in production costs is to reduce the output supplied at each level of prices, which means the short-run aggregate supply curve shifts up. This has occurred as a result of the current higher price that the firms are willing to charge in order to produce a particular level of output when expecting higher inflation rates in future. This shift of the short-run aggregate supply curve explains how changes in the expected rate of inflation allow the achievement of the overall price level and output in the economy in the short-run.