Problem: Reconsider your answer to Facts and Tools question. If you wanted to draw the long-run aggregate supply curve accurately, taking into account the idea that very high rates of inflation are likely to reduce real growth, how would you draw the long-run aggregate supply curve?
a. Would you draw a perfectly vertical curve, a curve with a positive slope, or a curve with a negative slope?
Question: To keep things simple, let's put this into a familiar supply and demand story and assume that in the long run, workers offer a fixed supply of labor: In other words, while they may be picky about jobs in the short run, in the long run they'll work regardless of the going wage.
It's the businesses who demand labor and workers who supply labor. Currently, let's assume the economy starts off at long-run equilibrium, so that the normal number of workers, Q*, are working.
a. Suppose labor demand falls, shifting to the left, as in the figure. What does the shortrun supply curve for labor look like if workers refuse to take pay cuts even if it means losing their jobs (we can call this the "take this job and shove it" strategy after the famous country and Western song). Indicate your answer by drawing a new line on the figure, labeling it "Short-run labor supply." You only need to focus on the area to the left of Q*.
b. Recalling your basic supply and demand model, does this fall in labor demand then create a "surplus" of workers or a "shortage" of workers?
c. According to the basic supply and demand model, what will happen to the price of labor over time as a result of this fall in labor demand?