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Why does inflation increase with GDP growth?

GDP Growth and Inflation

  1. Produced more at the same prices
  2. Produced the same amount at higher prices
  3. Produced more at higher prices
  4. Produced much more at lower prices
  5. Produced less at much-higher prices

Four of these scenarios either immediately or eventually cause higher prices or inflation.

Inflation Scenario 1

Scenario 1 implies production is being increased to meet increased demand. Higher production leads to a lower unemployment rate, further fueling demand. Increased wages lead to higher demand as consumers spend more freely. This leads to higher GDP combined with inflation.

Inflation Scenario 2

Inflation Scenario 3

Scenario 3 implies that there is both increased demand and shortage of supply. Businesses must hire more employees, further increasing demand by increasing wages. Increased demand in the face of decreased supply quickly forces prices up. In this scenario, GDP and inflation both increase at a rate that is unsustainable and is difficult for policymakers to influence or control.

Inflation Scenario 4

Inflation Scenario 5

Scenario 5 is very similar to what the United States experienced in the 1970s and is often referred to as stagflation. GDP rises slowly, below the desired level, yet inflation persists and unemployment remains high due to low production.

Three of these five scenarios include inflation. Scenario 1 eventually leads to inflation, and scenario 4 is unsustainable. From this, it’s clear inflation and GDP growth go hand-in-hand. (For related reading, see: The Importance of Inflation and GDP.)

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About Amy Harvey

Amy R. Harvey writes forStartUps Sections In AmericaRichest.

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