Answer Happy

Suppose that owing to frequent shifts in monetary policy, arrangements to index nominal wages W automatically to prices P begin to be adopted in the econ- omy. Assume that a 1% increase in P automatically increases W by some posi- tive amount, but by less than 1%. (d) [3 marks] Using the labour-market diagram, show what effect the indexa tion of wages has on the aggregate supply curve. (e) [3 marks] Do shocks to aggregate demand such as the example in part (a) have larger or smaller effects on the price level and real GDP with indexa- tion of wages than without indexation? Explain. (1) [4 marks] Do shocks to aggregate supply such as the example in part (b) have larger or smaller effects on the price level and real GDP with indexa- tion of wages than without indexation? What are the implications for the desirability of wage indexation? Explain.