EC111Class15Answers

EC111Class15Answers - EC111 MACROECONOMICS Spring Term 2012...

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EC111 MACROECONOMICS Spring Term 2012 EC111 Class 15 Solution Question 1. The aggregate supply schedule gives the output that firms wish to supply at each price level. This output is a function of inputs employed, labour in particular, and a firm’s labour demand in turn depends on the real wage. Thus, aggregate supply is tied closely to the real wage. (a) When the nominal wage is fixed, a rise in the price level decreases the real wage. As a result, labour demand (and hence output) increases with price. So, aggregate supply is an increasing function of the price level. Note that this analysis assumes that firms can obtain all the labour that they require at a given real wage. In other words, it said nothing about supply and equilibrium in the labour market. As the real wage changes with the price, firms move along their labour demand curves. They can only do so if there is excess supply of labour. For this reason, an upward sloping supply curve is associated with disequilibrium in the labour market. (b) If nominal wages adjust quickly, then the disequilibrium in (a) will not occur. Any change in the price level would be countered by an adjustment of the nominal wage that restores the equilibrium where labour demand is equal to labour supply. Only
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EC111Class15Answers - EC111 MACROECONOMICS Spring Term 2012...

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