... the short-run aggregate supply curve. This would lead to a rise in prices as well as an expansion in GDP. However, this would place the economy above long-run aggregate supply, and therefore producing more than its long-run potential. This means that the economy is operating with unemployment lower than the natural rate, and the ensuing labour shortages will lead to a rise in wages. At first glance, there does not seem to be any reason why this should lead to a process of inflation rather than just a one-off price rise. The graph below illustrates what might be expected to happen: Real GDP starts at Y0, with prices at P0. However, as aggregate demand shifts outward from AD0 to AD1, real GDP moves to Y1, with an accompanying price rise from P0 to P1. However, unemployment is now above its natural rate and therefore wages rise. This increase in ...

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