Question

AD-SRAS-LRAS model of the economy. Assume the SRAS curve is upward sloping.

a. Congress has debated raising the minimum wage to over $10 per hour. Doing so would permanently increase the production costs to businesses, especially those relying on lower-skilled workers. Use the AD-AS model to discuss the macro impacts on the price level, real GDP and unemployment.

b.The Federal Reserve has decided to design a policy response to the shift in part (a). What policy options are available and what are the associated trade-offs? Use an AD- AS diagram to support your opinion.

Answer 1

a) Congress has debated raising the minimum wage to $10 per hours. It will increase the cost of production of producers thereby induces producers to lower aggregate supply of goods which will shift supply curve to its left from AS to AS1. It result in rise in price from P to P1 and output to fall from Y to Y1. Producer will need less of the labor to produce less of the goods which will result in rise in unemployment.

b) Fed can either adopt expansionary monetary policy or contractionary monetary policy.

Expansionary monetary policy will raise money supply thereby raising willingness to pay by consumers and shift demand curve to its right. It will result in rise in price level while output level remains the same in long run.

Contractionary monetary policy will reduce money supply in an economy thereby reducing willingness to pay for goods by consumer which result in fall in aggregate demand in an economy. It will keep price same while output level will fall further.

Trade off between inflation and output occurs when Fed tries to solve the economic problem.