Cost-push inflation occurs when:

• A. a negative supply shock raises firms’ production costs and shifts short-run aggregate supply left, increasing the price level and decreasing real GDP
• B. an increase in consumer and investment spending shifts aggregate demand right, raising the price level and real GDP in the short run
• C. the central bank increases the policy interest rate, which immediately raises the price level while increasing real GDP
• D. a decrease in input prices shifts short-run aggregate supply right, lowering the price level and increasing real GDP

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of cost-push inflation. It occurs when the overall price level rises due to an increase in the costs of production, which reduces the short-run aggregate supply (SRAS).
2. Step 2: Identify what causes the short-run aggregate supply curve to shift left. This typically happens when there is a negative supply shock, such as higher input prices or increased production costs for firms.
3. Step 3: Recognize the effects of a leftward shift in SRAS. A decrease in SRAS leads to a higher price level (inflation) and a reduction in real GDP, as firms produce less at higher costs.
4. Step 4: Contrast cost-push inflation with demand-pull inflation, where aggregate demand shifts right, increasing both price level and real GDP, which is not the case here.
5. Step 5: Conclude that cost-push inflation is best described by a negative supply shock raising production costs, shifting SRAS left, increasing prices, and decreasing real GDP.