Macroeconomics: Theory and Policy

APPENDIX C

Aggregate Demand and Aggregate Supply

SUPPLY SHOCKS AND THE DILEMMA BEFORE THE POLICY MAKERS

A supply shock is a disturbance in the economy whose initial impact is to cause a shift of the aggregate supply curve. To analyse the supply shocks, we incorporate not only the labour costs but also the prices of raw materials.

Thus, the price equation can be written as

 

	P = W(1 + z) + θPm
where,	P = Price
	W = Wage in the current period
	z = Mark up over labour costs
	θPm = Material requirement per unit of output
	Pm = Prices of the materials
	θPm = Input cost of the materials.

 

Analysing the above equation, we observe that

1. The wage rate, W, and thus the price increases with the output level. ...