In the cost-push model of inflation, increases in nominal-wage rates that exceed increases in the productivity of labor:
A) Increase aggregate supply and the price level in the economy
B) Increase aggregate supply and decrease the price level in the economy
C) Decrease aggregate supply and the price level in the economy
D) Decrease aggregate supply and increase the price level in the economy

Question

Quizplus · Accepted Answer

In the cost-push model of inflation, when nominal-wage rates exceed increases in labor productivity, it raises the costs of production for firms, reducing their profits. Therefore, firms will reduce their output and supply of goods and services in the economy, decreasing aggregate supply. This reduction in aggregate supply causes an increase in the price level in the economy, as there is now less supply relative to demand. Therefore, choice D - Decrease aggregate supply and increase the price level in the economy is the correct answer.

In the Cost-Push Model of Inflation, Increases in Nominal-Wage Rates