Question

7.EXERCISE 15.2 POSITIVE AND NEGATIVE SHOCKS

Draw a labour market diagram where the economy is at labor market equilibrium with stable prices. Now consider:

• A positive shock to aggregate demand that reduces the unemployment rate by 2 percentage points.

• A negative shock that increases it by 2 percentage points.

1.What happens to the bargaining gap in each case?

2.What would you expect to happen to the price level in each case? Explain your answers.

Answer 1

Sol 7 :

the diagram for market equilibrium is as follows :

1) The effect on labour market will be as follows

• Impact of Increase in AD by 2% : Increase in Aggregate demand . that will increase the price for the wages for the workers and more labourers will be employed as increase in Aggregate demand will demand for more productivity which can be increase by employing more labours. this will shift the demand curcve of labours forward due to which situation of excess demand is created in the market . Due to excess demand (Bargaining gap) , price of the wages shift upward and quantity of labour is also increases and market will reach at equilibrium (E1) .
• Impact of increase in unemployment rate by 2% : Increase in unemployment rate this will decrease the price for the wages for the workers and less labourers will be employed as decrease in unemployment rate will will shift the demand curve of labours backward due to which situation of excess supply is created in the market . Due to excess supply (Bargaining gap) , price of the wages shift backward and quantity of labour is also decreases and market will reach at equilibrium (E1) .

2)effect on prices of wages will be as follows :

• Increase in wages of labours : As, due to increase in AD demand for labour increases and demand curve shifts from DD to DD' . Due to excess demand , price fro the wages will increases and quantity of more labour employed is also increased .
• decrease in wages of labours : As, due to increase in unemployment rate , demand for labour decreases and demand curve shifts from DD to DD' . Due to excess supply , price fro the wages will decreases and quantity of more labour employed is also decreased .