Suppose the price level falls but because of fixed nominal wage contracts, the real wage rises and firms cut back on production. This is a demonstration of the
A) sticky-wage theory of the short-run aggregate supply curve.
B) classical dichotomy theory of the short-run aggregate supply curve.
C) misperceptions theory of the short-run aggregate supply curve.
D) sticky-price theory of the short-run aggregate supply curve.

Question

Quizplus · Accepted Answer

This scenario is consistent with the sticky-wage theory of the short-run aggregate supply curve, which suggests that nominal wages are "sticky" and do not adjust immediately to changes in the price level. As a result, when the price level falls, the real wage (the purchasing power of wages) increases, leading to a decrease in firms' production and a decrease in the quantity supplied.

Suppose the Price Level Falls but Because of Fixed Nominal