00:01
So here i've drawn an aggregate demand aggregate supply graph with a level of potential output and the economy starting in a recession, right? here you see the equilibrium is to the left of the natural rate level of potential output, consistent with this idea that there's been this supply shock due to oil prices that's thrown the country into this recession.
00:21
The natural rate hypothesis says that in the long run, we return to y barner, right? so the argument is that the labor market is a self -correcting mechanism that will eventually get back to the natural rate of unemployment given time.
00:41
So something has to happen to get us back to this natural rate of unemployment, right? this sort of u -star level of unemployment that results in potential output being increased.
00:53
So something's got to happen to sort of move us to the right.
00:56
The first one is the correct answer, right? this is the correct answer.
00:59
Due to lower production, which has happened, right? you see how production has fallen.
01:03
The green level of output is lower than potential output.
01:06
Demand for labor will fall, wages will go down, costs will decrease, and the aggregate supply careful shift to the right.
01:12
That is precisely correct what will happen, right? the key thing is that unemployment gives power to the firm, right? the firm doesn't want as many workers.
01:28
So this means that the first, has all the power in the labor market.
01:33
At y1, there's lots of unemployment.
01:38
Production has fallen.
01:40
People have gotten laid off.
01:42
That gives firms a lot of bargaining power in the labor market, right? there's all this excess unemployment, and firms can be very picky about who they hire, and firms can offer low wages and still get them accepted because nobody is hiring.
01:55
So eventually, firms use this power to pay lower wages.
02:00
But that takes time.
02:01
Wages are sticky.
02:03
Wages do not change quickly, especially on a heavily regulated country like spain.
02:08
But as wages fall, that will reduce costs to firms.
02:12
And as costs to firms fall, some degree of competition in the market for goods will start lowering prices.
02:20
So slowly, slowly, slowly, depending on the speed of wage adjustment and the process of competition, passing those savings and wages onto consumers, you will eventually get, as real wages fall, more workers hired, and a return back to the natural rate, right? this is what happens.
02:40
The wages are sticky.
02:41
So when a shock to prices happens, wages are too high for the goods market to clear.
02:47
Wages need to adjust...