Question

(a) There are three reasons commonly given for the upward slope of the Short Run Aggregate Supply curve. Clearly explain all of them. (3 marks)

(a) Using an AD/AS model, explain the effects on both prices and output in the short and long run, if there is an increase in the overall wage rate in an economy. (7 marks)

Answer 1

a) Three reasons why the S.R.A.S. is upward sloping because:

1. The Sticky-Wage Theory: According to this theory, the A.S. is upward sloping as nominal wages are slow to adjust to changing economic conditions, i.e., they are “sticky” in the short run.
2. The Sticky-Price Theory: Just like the sticky wages, economists attribute the upward slope of A.S. to sluggishness of prices to adjust to changing economic conditions. In particular, menu costs, (i.e., costs associating with the printing and distributing catalogues and the time required to change prices) have been attributed to the rigidness of prices.
3. The Misperception Theory: As per this theory, changes in the overall price level may temporarily mislead suppliers/producers to adjust their price levels in their individual price market accordingly. This perception leads to an upward sloping AS curve.

b)

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