As above. appreciate if you could guide me in this aspect.
If there is an increase in aggregate demand, that means there is a rush for suppliers to produce more goods and services. At the same time, inflation has gone up from increased aggregate demand (draw the graph) meaning the REAL money wage rate of workers has declined and they are pissed since their money buys less stuff. Workers, being relatively smart, demand higher REAL wages to cope with increase in inflation and suppliers have to accept since they have to maintain or increase output levels. Therefore as wage rate increases, supply eventually shifts leftwards (the input costs to produce goods goes up so less supply offered) and the result is we are back at potential GDP. Hope this helps, Ali
I should note that we are back at potential GDP (long run aggregate supply) at a higher price level.
ali man nailed it , nice job.
First and foremost - wages are sticky. They are usually negotiated on an annual basis or when collectively based on future expectations of inflation rates. Now lets say there is a fiscal stimulus package from the government to increase aggregate demand through public spending. In the short run demand increases lets say for building new schools so that there is now demand for building contractors - supply increases. This can lead to building contractors offering higher wages to attract new workers. Look at the rate of wage inflation in India from foreign demand for IT services. But bear in mind real wages are sticky.
Good supplement. I guess it could also be noted that wages are also downward sticky - people are not willing to give up their salary if is a recession and real GDP is below potential GDP. Therefore a monetary policy to increase money supply would theoretically help bring the economy to potential GDP and out of recession. This is the precise reasoning for Keynesian and Monetarist economics.
I thought Money wage increases with price level to keep the real wage rate same… ******** Real wage = (Nominal wage)/(Price level) Sticky Wages: Nominal wages are sticky or inflexible. However firms make decision based on the real wage change. Worker Misperceptions: Workers misperceive real wage changes. Both nominal wage and price level increase so that real wage stays the same. Workers think that nominal wage increase meant also real wage increase. **********
I think it depends what increases aggregate demand, if it is a real economic increase in wealth (via improved technology for example) then I can see that real wages would rise. However, if it is a result of the government increasing money supply then Agg Demand may rise temporarily, but price levels will also rise by the same rate, and we are back to where we started, at least in real terms. I realize the CFA book does not fully agree with my second paragraph, but I don’t see how adding more pieces of paper to an economy can increase wealth. There is no free lunch.