Sia
Question
Statistics
Posted 7 months ago
Assume the country of Libertyville is currently producing at its full employment output.
What will be the long-run impact of a negative aggregate demand shock on nominal wages and the level of unemployment in Libertyville?
Choose 1 answer:
(A) Wages decrease; unemployment increases
(B) Wages decrease; no change in unemployment
(C) Wages increase; unemployment increases
(D) Wages decrease, unemployment decreases
(E) No change in wages; no change in unemployment
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Answer from Sia
Posted 7 months ago
Solution by Steps
step 1
To understand the long-run impact of a negative aggregate demand shock, we consider the classical model of the economy, which posits that in the long run, the economy operates at full employment
step 2
A negative aggregate demand shock initially leads to lower demand for goods and services, which can cause firms to reduce production and lay off workers, increasing unemployment in the short run
step 3
However, in the long run, nominal wages are flexible and will adjust downward to restore full employment, according to the classical model. This wage adjustment mechanism will lead to a decrease in nominal wages
step 4
With the decrease in nominal wages, firms can now afford to hire more workers at a lower cost, which will eventually bring the unemployment level back to its natural rate, which is the full employment level
step 5
Therefore, in the long run, the negative aggregate demand shock will result in lower nominal wages, but the level of unemployment will return to its natural rate, indicating no change in unemployment
Answer
B
Key Concept
Long-run adjustment in the classical model
Explanation
In the long run, nominal wages are flexible and will adjust to restore full employment, leading to a decrease in wages but no change in the natural rate of unemployment following a negative aggregate demand shock.
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