According to the sticky wage theory of the short-run aggregate supply curve if workers and firms expected prices to rise by 2 percent but instead they rise by 3 percent,
a real wages a rise, so firms will hire more workers.
b brise, so firms will hire fewer workers.
c fall, so firms will hire more workers.
d fall so firms will hire fewer workers.
The correct answer and explanation is:
The correct answer is d. fall, so firms will hire fewer workers.
Explanation:
The sticky wage theory suggests that in the short run, wages are “sticky,” meaning they do not adjust immediately to changes in the overall price level. Workers and firms set wages based on expectations of future price levels, and these wages typically remain fixed for a period.
In this scenario, workers and firms expected a 2% price increase, so they set wages based on that expectation. However, when the price level actually rises by 3% instead, the real wage (the wage adjusted for inflation) will be lower than expected. Real wages are calculated by adjusting the nominal wage for the inflation rate. If nominal wages remain the same (because they were set based on the expectation of a 2% increase), but prices increase by 3%, the real wage effectively falls.
As a result of the lower real wage, workers’ purchasing power is reduced. Firms, on the other hand, face higher prices for their goods, but their wage costs have remained the same. Since real wages are lower than expected, firms may find it less expensive to hire workers. However, if firms were expecting workers to be paid at the 2% inflation-adjusted rate, they may perceive the situation as less profitable. Consequently, they could reduce their demand for labor, leading to fewer hires or possibly even layoffs.
In summary, the key idea is that the price level has risen more than expected, leading to a lower real wage than firms and workers anticipated. This results in fewer workers being hired in the short run due to the mismatch between the nominal wage and the actual price level increase.