Discuss the three models of aggregate supply (fixed price model, rigid wage model and workers misperception model).

Answer 1

The three models of aggregate supply - the fixed price model, the rigid wage model, and the workers’ misperception model - all seek to explain how the aggregate supply of goods and services in an economy is determined. Each model posits different factors that influence the level of aggregate supply.

1. Fixed price model: In the fixed price model, it is assumed that prices are sticky and cannot adjust quickly in response to changes in demand or supply. This means that firms are unable to change prices in the short run, leading to a relatively fixed level of output. In this model, aggregate supply is determined primarily by the level of factor inputs and production capacity. Changes in demand can lead to temporary imbalances between supply and demand, resulting in fluctuations in output and employment levels.

2. Rigid wage model: The rigid wage model focuses on the role of wages in determining aggregate supply. In this model, it is assumed that wages are sticky and do not adjust quickly to changes in the economy. This can lead to a situation where firms are unable to adjust their labor costs in response to changes in demand, leading to fluctuations in output and employment levels. In this model, aggregate supply is influenced by the level of wages and labor costs, which can impact firms’ production decisions.

3. Workers’ misperception model: The workers' misperception model posits that workers have imperfect information about changes in the overall price level, leading to misperceptions about their real wages. This can lead to changes in the labor market that impact aggregate supply. For example, if workers perceive that their real wages are decreasing due to inflation, they may demand higher wages, leading to an increase in labor costs for firms. This can result in a decrease in aggregate supply as firms may reduce production to control costs.

Overall, each of these models offers different insights into the factors that influence aggregate supply in an economy. While the fixed price model focuses on the role of prices, the rigid wage model emphasizes the impact of labor costs, and the workers’ misperception model highlights the role of imperfect information in shaping labor market dynamics. By considering these different perspectives, economists can gain a more comprehensive understanding of how aggregate supply is determined in an economy.