If workers always see inflation coming, and if they demand wage increases in advance so that inflation does not erode real wages, then the economy's aggregate supply curve on the AD-AS diagram will
A)be a vertical line corresponding to potential GDP.
B)be a horizontal line corresponding to potential GDP.
C)slope downward.
D)slope upward.

Question

Quizplus · Accepted Answer

If workers always see inflation coming and demand wage increases in advance, firms will also increase their prices in anticipation of higher labor costs. As a result, the short-run aggregate supply (SRAS) curve will shift upward, and the economy will experience higher inflation along with higher output. In the long run, however, wages and prices will adjust fully to changes in the money supply or other shocks, and the SRAS curve will return to its original position at potential GDP, making the aggregate supply curve a vertical line. Therefore, the economy's aggregate supply curve on the AD-AS diagram will be a vertical line corresponding to potential GDP.

If Workers Always See Inflation Coming, and If They Demand