CH-4 MACROECONOMIC POLICY INSTRUMENTS
CH-4 MACROECONOMIC POLICY INSTRUMENTS
❑ In contractionary monetary policy pathway, the central bank causes the supply of money and credit in the
economy to decrease, which raises the interest rate, discouraging borrowing for investment and consumption,
and shifting aggregate demand left. The result is a lower price level and, at least in the short run, lower real GDP.
4.4 Income Policy and Wage
❖ Income policies in economics are economy-wide wages and price controls, most commonly instituted as a
response to inflation.
❖ Income policies vary from “voluntary” wage and price guidelines to mandatory controls such as price/wage
freezes.
❖ Income policy is the suitable complement for expansionary monetary and fiscal policies.
❖ In an inflationary environment, it is possible to stabilize the price level through the instruments of the income
policy.
❖ We can use these tools of the income policy to preserve price stability:
Determination of wage rates in a free market
➢ The price of labour, the wage rate, is determined by the intersection of supply and demand.
➢ When the supply of labour increases, the equilibrium price falls, and when the demand for labour increases,
the equilibrium price rises.
Cont …
❖ Market labour demand is a “price adjusted” downward- sloping curve, whereas, the market labour supply
however, generally slopes upward to the right, indicating that collectively workers will offer more labour hours at
higher relative wage rates.
❖ Higher relative wages attract workers away from either household production, leisure, or other labour markets
and towards the labour market in which the wage is increased.
❖ The vertical height of the market labour supply curve, measures the opportunity cost of employing the last
labour hour.
Price Floor
➢ A price floor is a government- or group-imposed price control or limit on how low a price can be charged for a
product, good, commodity, or service.
➢ A price floor must be higher than the equilibrium price in order to be effective.
Cont…
➢ Price floors are often imposed by governments; however, there are also price floors which are implemented by
non-governmental organizations.
➢ A price floor which is set above the market equilibrium price has several side-effects.
➢ Taken together, these effects mean that there is now an excess supply (known as a “surplus”) of the product in
the market to maintain the price floor over the long term.
➢ The equilibrium price is determined when the quantity demanded is equal to the quantity supplied.
➢ A price floor may lead to market failure if the market is not able to allocate scarce resources in an efficient
manner.