Cheaper to foreigners even though the Canadian aggregate price level stays the s
ID: 1201841 • Letter: C
Question
Cheaper to foreigners even though the Canadian aggregate price level stays the same. As a result, foreigners demand more Canadian aggregate output. Your study partner says that this represents a movement down the aggregate demand curve because foreigners are demanding more in response to a lower price. You, however, insist that this represents a rightward shift of the aggregate demand curve. Who is right? Explain. Your study partner is confused bv the upward-sloping short-run aggregate supply curve and the vertical long-run aggregate supply curve. How would you explain the difference? Suppose that in Wageland all workers sign annual wage contracts each year on January 1. No matter what happens to prices of final goods and services during the year, all workers earn the wage specified in their annual contract. This year, prices of final goods and services fall unexpectedly after the contracts are signed. Answer the following questions using a diagram and assume that the economy starts at potential output. a. In the short run, how will the quantity of aggregate output supplied respond to the fall in prices? b. What will happen when firms and workers renegotiate their wages? In each of the following cases, in the short run, determine whether the events cause a shift of a curve or a movement along a curve. Determine which curve is involved and the direction of the change, a. As a result of an increase in the value of the Canadian dollar in relation to other currencies, Canadian producers now pay less in dollar terms for foreign steel, a major commodity used in production,Explanation / Answer
Answer 2) An aggregate supply curve shows the quantity of all the goods and services that businesses in an economy will sell at a particular price level. In the long run, the aggregate supply curve is vertical, but the aggregate supply curve will be upward sloping in the short run.
Vertical Long run: The aggregate supply curve is completely vertical in the long run because the total production of goods and services in an economy is its real gross domestic product (GDP). In the long-run, GDP depends on the supply of labor, capital, land, natural resources, and the availability of technology to turn these resources into goods and services. In the long run, these factors of production determine the quantity of goods and services that are supplied in an economy. This quantity is the same regardless of a price level.
The upward slope of the supply curve for specific goods or services has to do with relative prices, which are simply the prices of goods and services compared to other goods and services. A business can take advantage of relative prices to increase production of a specific good or service.
Let's say that you own an industrial bakery where you mass-produce donuts and cinnamon rolls. The market price of donuts has increased. Assuming that the other prices in the economy remain constant, you can shift your labor and ingredients away from production of cinnamon rolls to donuts. In contrast, an entire economy's production is limited by available labor, capital, land, and natural resources. When prices rise at the same time in economy, there can be no change in the overall quantity of goods or service produced; you can shift production around, but the numbers remain the same because we are dealing with aggregates.
Upward Sloping in Short Run: In the short run, the aggregate supply curve will react to price level, which means it is upward sloping rather than vertical. If the price level increases, quantity supplied will increase. If the price level decreases, the quantity supplied will decrease. There are three theories to explain this positive relationship between price and quantity creating an upward sloping curve in the short run. It is as follows:
Sticky-wage theory: According to this theory, the short-run aggregate supply curve is upward sloping because wages take time to adjust to changes; wages are sticky. According to the theory, during the time it takes wages to adjust to a lower price level, production becomes less profitable, and businesses reduce supply as a result.
Sticky-price theory: The rationale behind sticky-price theory is the same as the sticky-wage theory but with regards to price of the good provided. Menu costs create stickiness in prices because of the costs and time required to change the price, such as costs of printing new sales materials and distributing catalogs and the time required for a retailer to change price tags. Businesses will temporarily reduce the quantity supplied until they can get prices unstuck.
Misperception theory: This theory holds that when a seller sees the price of its products decline, it makes an erroneous assumption that their relative prices have also declined. This misperception tends to induce sellers to supply less quantity to the market.
Answer 3 a) The short run wages are set by contracts, that is, workers are paid based on relatively permanent pay schedules that are decided upon by management or unions or both. When the economy changes, the wage the workers receive cannot adjust immediately.
Given that wages are sticky, when the price level falls, the nominal wage remains fixed because this is solely based on the dollar amount of the wage. Hence, the firm may temporary suspend some workers as the price level has fallen down and hence the output has to be reduced so that price does not fall any further.
Answer 3 b) If the firm renegotiates the wages, the amount paid to the labour will come down and this will reduce the cost of production also. Hence, the firm may again increase its output to the same level as the effective prices have come down.