Economy-Wide Wage Hike
The question
Assume the economy of Marloch is initially in long-run equilibrium. A wave of new labor contracts raises the nominal wages that firms across Marloch must pay their workers, and productivity is unchanged. Show only the short-run effect of this change on Marloch's economy, holding all else constant. Show the effect on the AD-AS Model graph.
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Economy-Wide Wage Hike: the worked answer
On the AD-AS Model graph, SRAS shifts left.
Why SRAS shifts left
Nominal wages are a cost of production for firms across the economy, so higher wages with unchanged productivity raise per-unit production costs. At every price level firms are now willing to supply less output, which shifts short-run aggregate supply to the left. The economy's quantity of resources and its technology are unchanged, so long-run aggregate supply stays put, and no spending component is directly affected, so aggregate demand does not shift.
What happens to the equilibrium
The equilibrium price level rises while real GDP falls below full-employment output, producing stagflation.
The mistake students make on this one
Students often shift AD right instead, reasoning that better-paid workers have more to spend. In the AP model an economy-wide nominal wage increase with unchanged productivity is a cost shock, and the AD answer predicts real GDP rising when the model says it falls.
On exam day
Nominal wages are the most heavily tested SRAS determinant, so commit the pairing to memory: wages up with productivity unchanged means SRAS left, every time.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when SRAS shifts left and every other curve on the AD-AS Model graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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