Demand-Pull Inflation at Full Employment

Steps:

• Recognize full employment means the economy operates at potential output with no spare capacity.
• An increase in total demand (aggregate demand) exceeds supply capacity.
• Output cannot rise significantly, so excess demand pushes prices upward.
• This results in higher inflation without changing employment levels.

Why D is correct:

• At full employment, increased aggregate demand causes demand-pull inflation, as defined in macroeconomic theory where price levels rise due to excess demand relative to supply.

Why the others are wrong:

• A: Rising demand boosts economic activity and incomes, likely reducing absolute poverty.
• B: No direct link to government spending or taxes; deficit depends on fiscal policy, not aggregate demand alone.
• C: Full employment implies unemployment at the natural rate, so it remains stable rather than increasing.

Final answer: D