Question

Suppose the US economy is in full employment. Describe the impact of each of the following events on aggregate supply:
• Union increasing the rate of wages by 10 percent
• Increasing the price level
• Increasing potential GDP

Answer 1

Aggregate supply is total supply of goods and services by producers in the economy for certain duration of rime.

( a ) When Union ( organization of labor ) increases the rate of wages by 10 percent, it would increase the cost of production for the producers leading them to remove workers in order to compensate for the increased cost which in turn would lead to fall in production of goods in the economy. Therefore, an increase in rate of wages will lead to fall in aggregate supply.

( b ) An increase in price level would incentivize producers to produce more of goods in lure of higher profits which in turn would lead to an increase in aggregate supply.

( c ) An increasing potential GDP encourages producers to producer more of goods and services in the economy leading an increase in aggregate supply.