Difficulty: Easy

Average Score: 75%

Why does the aggregate amount of output supplied increase when there is an increase in the price level in the short run

Rationale

Wages are sticky in the short run.

In the short run, wages do not adjust immediately to changes in the price level, causing firms to increase output when prices rise. This stickiness means that as prices increase, the real wage (the purchasing power of wages) decreases, making it more profitable for firms to produce more goods and services.

A (Interest rate is high in the short run.) YOUR ANSWER

While higher interest rates can impact investment and consumption, they do not directly explain the increase in aggregate output supplied when the price level rises. Interest rates typically affect demand rather than the supply side of the economy, making this choice irrelevant to the question.

B (The aggregate supply curve is vertical in the short run.) YOUR ANSWER

This statement is incorrect as the aggregate supply curve is not vertical in the short run; it is upward sloping. A vertical aggregate supply curve would imply that output does not change with price levels, which contradicts the observed behavior where firms supply more as prices increase due to sticky wages.

C (Wages are sticky in the short run.) CORRECT

In the short run, wages tend to be inflexible, meaning they do not quickly adjust to changing price levels. When prices increase, the purchasing power of wages falls, encouraging firms to produce more to take advantage of higher prices and maintain profitability, thereby increasing aggregate output.

D (Wages change fast in the short run.) YOUR ANSWER

This choice is misleading as it contradicts the concept of wage stickiness. If wages were to change quickly, firms would not respond to changes in the price level by increasing output, as the real wages would adjust simultaneously, negating the incentive to increase production.

Conclusion

The increase in aggregate output supplied with rising price levels in the short run is primarily due to the stickiness of wages. This phenomenon allows firms to respond to higher prices by boosting production, as the real wage effect encourages them to take advantage of increased profitability. Other factors, such as interest rates and the nature of the aggregate supply curve, do not adequately explain this relationship in the short run.

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