Let wages be indexed to inflation by a factor of 50 percent. A 1 percent price shock, in that case, ultimately produces an increase in prices of
A) 1 percent.
B) 2 percent.
C) 3 percent.
D) 1.5 percent.
E) none of the above.

Question

Quizplus · Accepted Answer

When wages are indexed to inflation by a factor of 50 percent, a 1 percent price shock leads to an increase in wages by 0.5 percent (50% of the initial shock). This increase in wages can lead to further spending and demand, potentially causing prices to rise again. The process can continue in a cycle, ultimately doubling the initial shock, resulting in a 2 percent increase in prices. This is a simplified explanation of how wage-price spirals can amplify initial price shocks in an economy.

Let Wages Be Indexed to Inflation by a Factor of 50