Figure 1.25: The WS-PS Model, Case 2: Employment Below Equilibrium

In an economy with a high level of unemployment, individual firms observe that they can attract a sufficient number of workers even if they offer lower nominal wages. If firms act on this observation to maximize their profits, what is the most likely sequence of events that will unfold, leading the economy toward a new state?

Firm Strategy in a Recessionary Economy

An economy is experiencing a period where employment is significantly below its natural equilibrium level. Arrange the following events in the logical sequence that describes the economy's automatic adjustment process back towards equilibrium.

Labor Market Self-Correction from High Unemployment

Firms' Incentives in a Low-Employment Economy

In an economy where employment is below its equilibrium level, the automatic adjustment process involves firms reducing nominal wages, which in turn causes the real wage to continuously fall until the new equilibrium is established.

In an economy with a high level of unemployment, an automatic adjustment process can occur. Match each cause listed on the left with its most direct and immediate effect from the list on the right.

In an economy with employment below its equilibrium level, firms are incentivized to expand production because the possibility of lowering nominal wages leads to higher ____, which in turn drives the economy back towards equilibrium.

Evaluating Policy Advice During a Recession

In an economy with widespread unemployment, a manager suggests, 'We can hire workers for less, which boosts our profit margin on each item. To maximize total profit, we should hire more workers but keep our product prices high to maintain this large margin.' Why does this strategy fail to capture the full picture of the economy's self-correction mechanism?

Low-Employment Disequilibrium in the WS-PS Model (Point C)

WS-PS Model's Prediction of the Unemployment-Inflation Relationship