Lower wages and lower input prices lead to:
a. decreases in the cost of production and a decrease in short-run aggregate supply.
b. decreases in consumer confidence and a decrease in aggregate demand.
c. decreases in consumer confidence and an increase in aggregate demand.
d. decreases in the cost of production and an increase in short-run aggregate supply
The correct answer and explanation is:
The correct answer is d. decreases in the cost of production and an increase in short-run aggregate supply.
Lower wages and lower input prices both reduce the cost of production for firms. When firms face lower costs, they are able to produce more at each price level. This leads to an increase in the short-run aggregate supply (SRAS) curve.
In the short run, aggregate supply is determined by the amount of goods and services firms are willing and able to produce, which is influenced by factors like wages, raw material prices, and other input costs. When these costs decrease, firms find it cheaper to produce the same amount of goods and services, or even increase production. This is particularly true for labor-intensive industries where lower wages directly reduce overall costs.
The decrease in production costs encourages firms to expand output. As output increases, the economy can experience more goods and services being available for consumers, which can lead to lower prices and possibly greater employment if firms hire more workers due to the increased output.
The increase in SRAS shifts the curve to the right, indicating a higher total output in the economy at every price level. This is generally associated with a decrease in inflationary pressure and can stimulate economic growth.
In contrast, a decrease in wages and input prices does not directly impact aggregate demand (AD). AD is influenced by factors such as consumer confidence, government spending, and interest rates, which are not directly tied to input costs or wages. Therefore, the primary effect of lower wages and input prices is an increase in SRAS, not a shift in AD.