Question

If an economy has aggregate price levels that are increasing, but the wage rate stays the same because of downward wage stickiness, what would be the economic consequences?

Group of answer choices

New businesses would enter the economy, hire employees and as a consequence the quantity of real GDP supplied would increase.

Business would need to hire more employees and the quantity of real GDP supplied would increase.

Business would fire some employees as labor becomes too expensive and the quantity of real GDP supplied would decrease.

Answer 1

The answer is (a) New businesses would enter the economy, hire employees and as a consequence the quantity of real GDP supplied would increase.

The cost of an employee to a firm is the real wage = Nominal wage - inflation

Now since the nominal wages are sticky but inflation is rising, the real wages are falling. The cost of production fo r a firm will fall and more firms will find it attractive to enter the market. a result, the AS curve shifts to the right and the equilibrium GDP will increase. The prices will fall.

(b) is wrong as there is no need for the firms to hire more workers as demand is not changing.

(c) is wrong as labor is cheap, not expensive.