Wages Rise Across the Economy
An economy-wide rise in nominal wages raises production costs, shifting SRAS left and producing cost-push inflation.
Wages Rise Across the Economy
AD-AS ModelAn economy-wide rise in nominal wages raises production costs, shifting SRAS left and producing cost-push inflation.
Equilibrium at Real GDP (Y) 80, Price Level (PL) 60
Long-run equilibrium
The economy starts in long-run equilibrium, where AD meets SRAS on LRAS. Real GDP is at the full-employment level and unemployment sits at its natural rate.
Now try it yourself: shift the curves in a graded FRQ drill, or open this graph in the free sandbox.
Students predict what happens before the graph moves. No accounts, nothing graded.
Wages Rise Across the Economy, step by step
- 1
Long-run equilibrium
The economy starts in long-run equilibrium, where AD meets SRAS on LRAS. Real GDP is at the full-employment level and unemployment sits at its natural rate.
- 2
Nominal wages rise, SRAS shifts left
Wages are the largest input cost for most firms. When nominal wages rise across the economy, each unit costs more to produce, and wages are an SRAS determinant, so firms supply less at every price level and SRAS shifts left. Aggregate demand has not moved, because no one has changed C, I, G or Xn.
- 3
Cost-push inflation and a recessionary gap
AD crosses the new SRAS at a higher price level and a lower real GDP. Inflation caused by rising costs rather than rising spending is cost-push inflation. Because output has fallen below the full-employment level marked by LRAS, the graph shows a recessionary gap, so higher inflation and higher unemployment arrive together.
- 4
Tell it apart from demand-pull
In demand-pull inflation, AD shifts right and the price level and real GDP rise together. Here the price level rises while real GDP falls, and that opposite movement is the exam tell that the shock hit the supply side. Check which way output moved before you name the type of inflation.
- 5
Beyond what the graph shows
The graph stops at the short-run gap. Left alone, persistent unemployment would eventually slow wage growth, shift SRAS back right, and return output to full employment. That correction is described here in words and is not on the graph.
Where it ends up
Higher nominal wages shift SRAS left, so the price level rises while real GDP falls below full employment. That is cost-push inflation with a recessionary gap.
Now draw it yourself
Same graph, graded on whether you move the right curve and leave the rest alone.
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