Assume that the economy is initially at full-employment. With the aid of AD-AS diagram, illustrate and explain how a fall in interest rate would lead to inflation. Indicate the type of inflation.

1. **Initial Condition:** Economy is at full employment, aggregate demand AD_0 intersects aggregate supply AS at point E_0 with price level P_0 and output Y_f .

AD_0 \cap AS = (P_0, Y_f)

2. **Fall in Interest Rate:** This leads to increased consumption and investment, shifting AD to the right from AD_0 to AD_1 .

AD_1 > AD_0

3. **New Equilibrium:** The new aggregate demand AD_1 intersects aggregate supply AS at point E_1 with a higher price level P_1 but the same output level Y_f indicating demand-pull inflation.

AD_1 \cap AS = (P_1, Y_f)

4. **Conclusion:** The higher price level P_1 from the increased AD results in inflation.

\text{Demand-Pull Inflation}