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lecture 12 - 1 Here is what we have learned from the labor...

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1. Here is what we have learned from the labor market when prices increase (just the opposite occurs when prices decrease). A. after stage one (we are in the short run), we find P ↑, W eq ↑, N eq ↑, Y S ↑, W/P ↓ and W/p e Laborers think they are better off and thus they work more. However, they are actually worse off and should be working less. There is a tradeoff between prices and output. To get more output, an economy must put up with more inflation. This trade off only occurs because of misinformation, however, and if labor knew the price change they would not work as much and there would be no gain in output. B. after stage two (we are in the long run), we find P↑, W eq ↑, N eq ,↔ Y S ↔, W/P ↔, and W/p e
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Once laborers find out about the price change, they can adjust to it. In the end there are no changes in real variables and prices and wages rise by the same percentage. There is a no tradeoff between prices and output and output in the long run. This would seem to make sense since firms do not produce goods from prices. Rather, they use resources. While the economy will work its way out of the short run problems if it is given enough time, policy might still be needed to make the SR problems last for a shorter period of time and be less severe.
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