Figure 16-6
-Refer to Figure 16-6. Suppose the economy was operating at point e in period 1. Expansionary fiscal and monetary policies adopted in period 1 resulted in a movement to point g in period 3. What happens when workers and firms become aware of a rise in the general price to P_g?

Question

Figure 16-6

-Refer to Figure 16-6. Suppose the economy was operating at point e in period 1. Expansionary fiscal and monetary policies adopted in period 1 resulted in a movement to point g in period 3. What happens when workers and firms become aware of a rise in the general price to P_g?

Quizplus · Accepted Answer

When workers and firms become aware of a rise in the general price level, they will revise their expectations of future prices to incorporate the higher price level. This means that they will expect prices to continue rising, which could lead to a wage-price spiral and further inflationary pressure. Option A is unlikely as workers are usually resistant to accepting wage cuts once they have been agreed upon. Option C is only applicable to firms with sticky prices, which are a minority of firms in the economy. Option D is also unlikely as firms and workers would prefer to maintain their previously agreed-upon wage contracts.

Figure 16-6 -Refer to Figure 16-6. Suppose the Economy Was Operating at Was