Question

How do firms respond when production costs rise as a result of nominal wages being negotiated upward due to inflationary pressure?

A. They reduce input costs to offset wage increases.
B. They increase hiring to expand production.
C. They decrease aggregate demand.
D. They increase output prices to match the expected rate of inflation.

Answer 1

Firms can reduce input costs or increase output prices in response to rising production costs due to wage increases.

Step-by-step explanation:

When production costs rise due to nominal wages being negotiated upward as a result of inflationary pressure, firms have several options to respond. One common response is to reduce input costs to offset the wage increases. This can be done by finding cheaper suppliers, improving production efficiency, or using alternative materials. Another option is to increase output prices to match the expected rate of inflation.

This allows firms to pass on the higher costs to consumers. However, increasing prices may result in decreased demand for their products. Overall, the response of firms to rising production costs due to wage increases depends on various factors such as market conditions, competition, and the elasticity of demand.