Question

Discuss the following statements:

1. The aggregate supply relation implies that an increase in output leads to an increase in the price level.

2. The natural level of output can be determined by looking only at the aggregate supply relation.

3. The aggregate demand relation implies that an increase in the price level leads to an increase in output.

Answer 1

1) The statement is true as when output rises, employment level rises which cause nominal wages to rise which raise the willingness to pay of individual in the market and induce firms to raise the price level due to higher wages.

2) True as natural level of output is determined through labor market. When the good supplied by producer according to supply curve at a specific price level is related to wages paid by firm to labor in terms of real wage as real wage are Wages / Price level, it determines the output produced in economy.

3) False, a reduction in price level leads to an increase in output as prices and output consumed have inverse relationship with each other.