What happens when bad aggregate demand shocks hit the economy? Consider the following graph. : lop1 Its
Question:
What happens when bad aggregate demand shocks hit the economy? Consider the following graph. : lop1
It’s the businesses who demand labor and workers who supply labor. Currently, let’s assume the economy starts off at long-run equilibrium, so that the normal number of workers, Q*, are working.
a. Suppose labor demand falls, shifting to the left, as in the figure above. What does the short-run supply curve for labor look like if workers refuse to take pay cuts even if it means losing their jobs (we can call this the “take this job and shove it” strategy after the famous country and western song). Indicate your answer by drawing a new line on the figure above, labeling it “short-run labor supply.” You only need to focus on the area to the left of Q*.
b. Recalling your basic supply-and-demand model, does this fall in labor demand then create a “surplus” of workers or a “shortage”
of workers?
c. According to the basic supply-and-demand model, what will happen to the price of labor over time as a result of this fall in labor demand?
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