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Use the sticky-wage theory of aggregate supply to explain what will happen to output and the...

  1. Use the sticky-wage theory of aggregate supply to explain what will happen to output and the price level in the long run (assuming no change in policy). What role does the expected price level play in this adjustment?

Be sure to illustrate your analysis in a graph.

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Ans: A sticky-wage theory of aggregate supply basically discusses its unchanged wage rate. so when there is a price level down due to decrease in AD1 to AD2, wages can't be cut due to a fall in short run price level, so the no. of employment and production will be reduced like point B. In the long run, it will be more flexible and it adjusts according to the expectation so shift in AS1 to AS2 . so finally, it will achieve the natural rate of output i.e. point C.

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