MaddiC
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So I'm guessing a reduction in the minimum wage causes the AS to shift to the right as the cost of production falls (possibly?). But I'm not sure how that affects the IS and LM model.
Can anyone help me?
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Classical Liberal
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(Original post by MaddiC)
So I'm guessing a reduction in the minimum wage causes the AS to shift to the right as the cost of production falls (possibly?). But I'm not sure how that affects the IS and LM model.
Can anyone help me?
The IS-LM model is used to derive the AD curve. IS-LM to show how output changes when the nominal price level changes, which is negatively. This is because a fall in the price level increases the real money supply. This shifts the LM curve out, which increases output.

In the first year AS-AD model, the AS curve is usually split in two parts. The short run and the long run. The long run AS curve is a vertical line, and is consistent with wage expectations being equal to actual wages. The short run is upward sloping, and is consistent with expectations being different from actual wages. Not sure how helpful this model is when it comes to analysing the effects of the minimum wage on the economy.
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MaddiC
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Thank you, that was really helpful.
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RowanL
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Not sure if this is too late for you now but what the minimum wage falling does depends on where it actually is currently set i.e. if it is set below the equilibirum wage, in the wage setting/price setting curves you should see no change in the AD/AS diagram. (Unless you are being specifically asked about the AS/AD I would use a WS/PS diagram (non-competitive markets) or a labour supply/marginal product of labour diagram (perfectly competitive markets).

If the minimum wage is set above the equilibrium wage in the WS/PS diagram then yes I would expect wages to fall, costs of production to fall and supply (both LR and SR) to therefore shift outwards.
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MaddiC
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This would be the short run affects right? Meaning in the short run, a reduction in the minimum wage causes the AS to shift to the right, causing price levels to fall and output to rise (from yn to y). Whilst the LM curve shifts outwards causing the interest rate to fall.
What happens in the medium run? I'm assuming the output goes back to its natural level. But I'm not sure why.
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