If there is an increase in wages, what is the short-run effect on the economy?

An increase in wages typically leads to higher production costs for businesses. In the short run, as firms deal with this increase in labor costs, they may respond by reducing the quantity of goods and services they are willing to supply at existing price levels. This results in a leftward shift of the Short-Run Aggregate Supply (SRAS) curve.

As the SRAS curve shifts leftward, the economy experiences cost-push inflation. This means that the overall price level in the economy increases due to higher costs of production. When production becomes more expensive, firms often pass these costs onto consumers through higher prices, resulting in inflation.

The leftward shift of the SRAS curve contrasts with the idea of demand-pull inflation, which is associated with an increase in aggregate demand, leading to higher output and prices, rather than rising costs. In this context, the correct answer underscores the relationship between increased wages and the upward pressure they place on production costs, which can lead to inflation in the short run.