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The Mechanism of an Accelerating Wage-Price Spiral
An accelerating wage-price spiral is a self-perpetuating cycle that occurs when low unemployment persists. After an initial wage increase (e.g., 7%) raises production costs, firms use markup pricing to pass this on as a price increase of the same magnitude. This erodes workers' real wages again, prompting them to demand an even higher nominal wage in the next round, which incorporates the new, higher inflation rate plus the original bargaining gap (e.g., 7% expected inflation + 2% bargaining gap = 9% wage demand). As long as the positive bargaining gap remains, this cycle repeats, causing the inflation rate to increase by the size of the bargaining gap each year.
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Introduction to Macroeconomics Course
Ch.4 Inflation and unemployment - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Definition of the Wage-Price Spiral
The Mechanism of an Accelerating Wage-Price Spiral
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Definition of a Wage-Price Spiral
An economy is experiencing a period of very low unemployment, creating a consistent 2% 'bargaining gap' where workers' desired real wage is 2% higher than what firms can offer while maintaining their profit margins. In Year 1, inflation was 0%. In Year 2, to achieve their desired real wage, workers successfully negotiate a 2% nominal wage increase, and firms respond by raising prices by 2%. Assuming the bargaining gap remains and workers form their inflation expectations based on the previous year's inflation, what nominal wage increase will workers demand in Year 3, and what will the resulting inflation rate be?
An economy is experiencing persistent low unemployment, which has created a positive 'bargaining gap'. The following events describe the cycle that causes inflation to accelerate. Arrange them in the correct logical order, starting immediately after an initial round of wage increases has occurred.
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