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Why is that when there is spare capacity in the economy, increasing AD, has no effect

on the general price level?

p.s. I'm referring to the AD/AS curve, initially horizontal and then a vertical line.
(edited 8 years ago)
Original post by SANTR
on the general price level?

p.s. I'm referring to the AD/AS curve, initially horizontal and then a vertical line.


Assuming that you are talking about these(below), increase in AD always has an effect on the general price level, but when the spare capacity is big, its effect is minimised because AS curve is flatter . Imagine the shift of AD to AD1 taking place much closer to the y-axis in the diagram :smile: hope this helps.
Reply 2
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econam
11
From a demand perspective, inflation doesn't occur when there is spare capacity because growth in demand doesn't outstrip that of supply and demand pull inflation doesn't occur. In a diagram it is shown by a shift along the horizontal part of Lras. Thus causing an increase in Y but no increase in the price level.

From a supply perspective inflation could still occur. For example, if there was a rise in commodity prices on the international market.


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