On the demand shock side, the higher wages provide more buying power to the workers and fuels higher aggregate demand, which further pushes up the price. But the firms will also lay off workers, which will dampen the aggregate demand shock effect as well!

Now, let's us suppose that there is no union win as yet. However, a prior long-term contract between workers and the firm is in effect.Under this contract the firm had agreed in advance to pay workers an hourly wage of $20 based on the expectation that the price level would be 100. But the price level turned out to be actually 95, so the firm receives 5% less for its output than it expected and its labor costs are fixed at $20 per hour.

Consider the Sticky Wage Theoryto figure out what will happen to the number of workers employed and the output supplied.