There are two economies both in recession. In the first economy all workers have long-term contracts that guarantee high nominal wages for the next five years. In the second economy all workers have annual contracts that are indexed to changes in the price level. Which economy will return to the natural rate of output first? Explain your response. How would you describe price levels in the first economy?

 

2.) A sudden increase in aggregate demand moves the economy from its long-run equilibrium. Illustrate this change using the aggregate demand-aggregate supply model. What are the effects of the change in the short and in the long run?