Answer to Question #246894 in Microeconomics for Nishu

Question

Consider an Economy in its medium run equilibrium. Now suppose that the government passes a stricter law against the exercise of market power leading to decline in mark-up over wages. Explain using IS-LM and AD-AS curves how it will affect price level, interest rate and output in the short run and in the medium run.

Answer 1

Solution:

The decline in mark-up over wages will lead to a decline in the price level, interest rate, and output. The IS curve will shift to the left as the interest rate and output falls.

The aggregate demand will also fall and shift to the left as price level and output levels.

 

This is displayed by the below graph: