Explain about labor market in as-ad model, Macroeconomics

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Q. Explain about Labor Market  in AS-AD model?

In AS-AD model, economy will always be on the response curve - the thick line in chart below. 

1736_Explain about Labor Market  in AS-AD model.png

Figure: The labor in the AS-AD model

Response curve has a horizontal part and a downward sloping part. In IS-LM model, we had only horizontal as real wages where constant. We couldn't move beyond LB

We can illustrate the response curve by examining economy moving from point A to point C. 

  • First, economy is at point A, with prices P, wages W, real wages W/P and amount of labor LA. Profit-maximizing quantity of labor is LBthough firms don't choose this quantity owing to the lack of demand.
  • If aggregate demand increases, L can increase without P being affected up to L = LB. To the left of point B, IS-LM model is completely sufficient and AS-AD model is redundant.
  • When L = LB, L can't increase without real wages falling. In AS-AD model real wages are decreased by an increase in P (with W constant) and we begin to move down demand curve for labor.
  • Between the points B and C, L will increase when P increases.
  • Though we can't increase L above LC. When we are at point C, not even a price increase will help. Real wages are no so low that labor supply sets the limit - there are no more people who want to work for these low real wages.

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