1. will always cause aggregate output and employment to increase.
2. will always cause the real wage rate to increase.
3. will cause the aggregate supply curve of labour to remain unchanged if workers and firms perceive the observed shifts in the demands for their output to be specific to their own industries.
4. will do all of the above.
Choose the correct option.
The correct answer is option 3. The supply curve of labour will only shift up if workers and firm attach some probability to the possibility that the shock is economy-wide. If they know that the shock is economy-wide, the supply curve will shift up in proportion to the upward shift of the demand curve and employment and the real wage rate will remain unchanged.
If the supply curve of labour does not shift up in proportion to the shift of the demand curve, employment will increase. The expected price level will increase in proportion to the upward shift of the supply curve and the actual price level will rise by a larger amount if employment increases. Increases in output and employment will thus be associated with increases in the actual relative to the expected price level.