If real wages are sticky and export demand permanently declines, then
A)import prices will fall
B)the domestic currency will appreciate
C)a recession will result, but it will be short-lived since nominal wages will adjust immediately
D)a prolonged period of unemployment will result
E)the current account will show a surplus

Question

Quizplus · Accepted Answer

If real wages are sticky and export demand permanently declines, then firms will face lower demand for their goods and services. As a result, they will reduce production, which will lead to layoffs and a prolonged period of unemployment. Since real wages are sticky, nominal wages will not adjust immediately, so the labor market will not clear, and unemployment will persist. Option A is incorrect since if import prices fall, it would imply that the domestic currency has appreciated. Option B is also incorrect since a decline in export demand will put downward pressure on the domestic currency. Option C is incorrect since nominal wages are sticky, so a recession will not be short-lived. Option E is incorrect since a decline in exports will lead to a current account deficit (due to lower export revenues).

If Real Wages Are Sticky and Export Demand Permanently Declines