Question

This deals with Aggregate demand and Aggregate Supply

Question) In Wageland, all workers sign an annual wage contract each year on January 1. In late January, a new computer operating system is introduced that increases labor productivity dramatically. Explain how Wageland will move from one short-run macroeconomic equilibrium to another. Illustrate with a diagram.

Answer 1

Ansss
As it can be seen in the diagram that initial equilibrium is at point E1, where AD and SRAS1 cut each other. But when a new computer operating system has been introduced in the company, and it has increased the labor productivity and it causes more production of goods and services in the economy. Therefore the SRAS curve shifts rightward from SRAS1 to SRAS2. This leads to increase in the real GDP from Y1 to Y2 and decrease aggregate price level from P1 to P2. All this has been shown in the below diagram. The new equilibrium price is P2 and real GDP is Y2 and new equilibrium point will be E2.
Since each year on January 1, the wage is set for the whole year and the labor productivity has increased due to the introduction of new computer operating system in the late January. Due to this the price level has decreased in the economy, so the firm should cut the wages of the workers but it cannot be done by the firm in between the year because the wage has been already set for the whole year in the beginning of the January. But firm may cut the wages in the next year but in this year wages remain same.