Supply-Side Equilibrium: Unemployment and Inflation?
PROFIT IS EQUAL TO REVENUE MINUS COST, WHERE REVENUE EQUALS PRICE TIMES QUANTITY OF OUTPUT, WHILE COST EQUALS THE WAGE RATE TIMES EMPLOYMENT (ASSUMING WAGES ARE THE ONLY COST OF PRODUCTION). ASSUME THAT, ON AVERAGE, EACH FIRM PRODUCES 100 UNITS OF OUTPUT A DAY, EMPLOYS 90 WORKERS AND PAYS A WAGE OF $100 A DAY.
As the price of output rises from $80 to $90, $100, $110, and $120, show how the profitability of firms changes.
At which of these price levels will firms have an incentive to raise or lower output?
From these observations, construct an aggregate supply curve.
Explain how the slope of the aggregate supply curve is likely to be influenced by the following circumstances.
Wages and other costs of production are firmly set by binding contracts that cannot be renegotiated until two years after either side has given notice.
Contracts specify that wages and other costs of production are to rise immediately by one half of the percentage increase in the consumer price index. Full adjustment still has to await the renegotiation that can occur after two years.
Contracts specify that wages and other costs rise immediately by the full amount of any increase in the consumer price index.
Use aggregate supply and demand diagrams to predict the change in GDP and the price level when the following occur:
New varieties of high-yielding grains are developed.
A round of collective bargaining in the industrial sector leads to relatively high wage increases.
Pessimistic business forecasts lead firms to reduce their planned investment.
An announcement of major increases in social security retirement benefits leads people to reduce their personal saving.
The population grows, increasing both the labor force...
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