Infrastructure investment → Inflation: chain of analysis

ChainWhat it assumes · how to break it

Start

The government invests in infrastructure, for example new rail links, roads, broadband and energy networks.

As a result, construction spending adds to AD in the short run.
aggregate demand

Assumes: The spending is new rather than switched from elsewhere.

But: If other spending is cut to pay for it, AD barely changes.

This means if the economy is near capacity, competition for construction workers and materials pushes up costs and prices.
demand-pull inflation

Assumes: The economy is near full capacity.

But: With spare capacity, the extra demand raises output with little inflation.

Once complete, lower transport and energy costs reduce firms' costs of production, shifting SRAS and LRAS to the right.
SRAS · LRAS

Assumes: The project cuts firms' costs.

But: The savings may be small compared with firms' total costs, and new roads can fill with traffic, eroding the time savings.

Therefore, in the long run the economy can grow faster without prices rising, because capacity grows alongside demand.
non-inflationary growth

Best link to attack
Assumes: The supply-side gain arrives and is large enough.

But: The inflationary effect comes first and is certain; the supply-side gain comes years later and is uncertain.

End

Inflation may rise in the short run but falls in the long run.

Can you say this chain from memory?
Members can hide the links, test themselves and track which chains they have mastered.

Explain how infrastructure spending might affect inflation in the short run and the long run.
Assess the view that supply-side policies allow non-inflationary growth.
Discuss the macroeconomic effects of a large public infrastructure programme.

AD/AS: AD shifts right first, raising the price level; LRAS then shifts right, bringing it back down.

Cuts to infrastructure → less demand pressure now, but slower capacity growth later.

GCSE version