Question

Explain and discuss whether each of the following statements is true or false (please explain)

1. The aggregate supply function is upward sloping because at higher expected price levels, firms wish to produce more output.
2. In the medium run output and the price level always return to their same (original) values after a demand shock.
3. An increase in the minimum wage will cause an increase in the natural rate of unemployment with an increase in the equilibrium real wage.

Answer 1

A.

True

Though the aggregate supply or AS function is at macro level, but it reflects the overall behavior of the firms across the industries. When price level increases, then real value of wages paid to the workers also decreases, though nominal wage remains same. At this scenario, firms want to produce more and maximize their profit level, as they have to pay wages that have lower real values. It makes AS curve to be upward sloping.

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B.

False

Price does not return to the original level in the medium run and a different price level will be achieved in the given scenario. Though, output level can be at the original level if their is a demand shock.

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C.

True

Increase in real wage is a structural change, enforced by the legal provisions. So, unemployment due to this reason is structural unemployment. Hence, increase in structural unemployment is also going to increase natural rate of unemployment.