Workers and firms both expect that prices will be 2.5% higher next year than they are this year.As a result
A)workers will be willing to take lower wages next year, but not lower than a 2.5 percent decrease.
B)the purchasing power of wages will rise if wages increase by 2.5%.
C)the short-run aggregate supply curve will shift to the left as wages increase.
D)aggregate demand will increase by 2.5%.
E)long-run aggregate supply will shift to the right by 2.5%.

Question

Quizplus · Accepted Answer

When workers and firms expect prices to increase, workers will demand higher wages as well in order to maintain their purchasing power. As a result, firms will face higher costs of production and will reduce production levels, leading to a leftward shift in the short-run aggregate supply curve. This will cause prices to increase further, eventually leading to a new equilibrium level. Option A is incorrect because workers will not accept lower wages than what they currently receive, even if they expect higher prices in the future. Option B is incorrect because the purchasing power of wages will not rise if wages increase by the same amount as expected inflation. Option D is incorrect because aggregate demand will not increase by 2.5%, as this is merely an expectation of higher prices rather than an actual increase in real income. Option E is incorrect because long-run aggregate supply is determined by factors such as technology and labor force participation rates, and does not shift due to short-term expectations of price changes.

Workers and Firms Both Expect That Prices Will Be 2