wage price spiral Flashcards
wage price spiral answer
the economy is initially in equilibrium where AD=SRAS=LRAS with real output yf and average price level p
There is an increase in government spending in the economy which shifts ad to ad1 resulting in a new short run rqulibrim where AD1=SRAS with higher real output y1 and a higher average price levels. As the eeocmomy is now producing above its potential output workers are being over worked and so they start to bargain for higher wages.
this pushes costs uo for firms meaning they are able to produce less causing SRAS to shift to the left SRAS1.
This continues to happen until workers are no longer being overworked which occurs when the economy is no longer producing above its potential output. Hence the long run equilibrium is where AD1=SRAS1=LRAS real output has returned to yf and the average price level has increased to P2. Hence demand side policies only cause inflation in the long run in the new classical model
