The fact that nominal wages are fixed by a contract at the beginning of a period while prices of goods may change within that period, implies that
A)unanticipated changes in the money supply do not affect the level of output
B)there is no trade-off between unemployment and inflation
C)firms want to supply more output when prices increase since the real wage rate is lower
D)anticipated monetary policy changes will not affect the level of inflation
E)money supply changes affect prices but not unemployment in the short run

Question

Quizplus · Accepted Answer

Nominal wages are fixed in the short run, which means that if prices increase, the real wage rate decreases, which incentivizes firms to produce more output to take advantage of the cheaper labor costs. This relationship is known as the sticky-wage theory, and it implies that there is a trade-off between unemployment and inflation in the short run. Anticipated monetary policy changes can still affect the level of inflation, as changes in expectations can influence economic behavior. Unanticipated changes in the money supply can also affect the level of output through their impact on real interest rates and other channels.

The Fact That Nominal Wages Are Fixed by a Contract