WS Curve (Wage Setting Curve)
: Represents the 
relationship between the 
level of employment (E) 
and real wages (W). It 
shows how changes in 
employment affect real 
wages. As employment 
increases, real wages 
tend to increase due to 
higher demand for labor.

PS Curve (Price Setting Curve)
: Represents the 
relationship between 
the level of employment (E)
and prices. It shows how 
changes in employment affect
prices. In the short run, 
prices are assumed to be 
fixed, but in the medium 
run, prices adjust to 
changes in employment.

E (Employment): Represents 
the level of employment in
the economy. E0, E1, E2 
represent different levels 
of employment, with higher
values indicating higher 
levels of employment.

W (Real Wages): Represents 
the real wage rate in the 
economy. w0, w1, w2 
represent different levels 
of real wages, with higher 
values indicating higher 
real wages.

The horizontal axis shows 
the employment (E) with 
different employment level
(E0, E1, E2, E3)

The vertical axis shows 
the wages (w) with different
wages setting (w0, w1, w2)

For the WS-PS model two 
cases are possible :

An expansionary fiscal policy 
in a fixed exchange rate

An expansionary fiscal policy 
in a flexible exchange rate 



An expansionary fiscal policy 
in a fixed exchange rate :


First we are in a short run, 
prices and wages are fixed, 
market structure is given and
capital is constant

An expansionary fiscal policy 
means on increase of G 
(Government spendings), 
which will leads to an 
increase of y, yd.

At the end, we get an in
increase of y and an expansionary
fiscal policy under fixed 
exchange rate is effective

Higher Y, leads to an 
increase of Employment,
leading to a shift of 
the equilibrium employment
from A point to the right, 
to C, so with a fixed wage 
(w0), we have a higher
employment, E0 to E1


Now we we turn from a short 
run model to a medium 
run model, to adjust prices
and wages and see the effect
on the Employment.

Now, because employment 
increased, wages increased, 
that means that the labor 
cost to produce goods
and services is going to 
increase  = companies increased
their prices of goods 
to balance the increase 
of labor cost, in order to be
profitable. 

Because price of home goods
increased, that means that the
real exchange rate (ø) 
decreased, price of foreign 
goods expressed in home 
currency is lower than 
price of home goods, the real
exchange rate appreciates, 
imports are going to increase
and exports are going to 
decrease, leading to deterioration
of the BT (trade balance) = 
Y (income) is going to decreased
= Employment is going to 
decrease 

So point the equilibrium of
employment will shift to 
the left from point C to 
point B, with point B the 
new medium run equilibrium 
of employment

At the end = higher employment 
(E1) and a higher wages (w2).



An expansionary fiscal policy 
in a flexible exchange rate :


First we are in a short run, 
prices and wages are fixed, 
market structure is given and 
capital is constant, the real
exchange rate (ø) is constant,
e (nominal exchange rate) is 
fixed and P and P* are growing
at the same rate.

Expansionary fiscal policy 
means an increase of G 
(Governement spendings),
leading to increase Y (Income)
and yd (aggregate demand),
leading to an increase of
Employment and we have a BP
surplus, i>i*, so there is a 
capital inflow and an 
appreciation of the real 
exchange rate (decreased of 
the real exchange rate ø),
that means that price of 
foreign goods is lower than 
price of home goods = foreign
goods are cheaper than home
goods = increased of imports,
decreased of exports = 
deterioration of BT (Balance
of trade) = decrease of y

So at the end, we got for a
same interest rate, same Y
(Income) so the level of
employment is going to
stabilize at E0 and we got
higher wages leading to a
shift from A point to D point,
so higher wages (w0) to (w2)


Now we are in a medium run, 
prices and wages can be 
adjust.

Because employment stabilized,
and wages increased, wages are
going to decrease to match
the actual level of employment
(E0) which leads to a cost of
labor to produce goods 
decreased (cost composed of 
wages, bonus and benefit of 
employees), so companies can 
decreased their prices, 
because the cost of labor 
decreased, that means that 
the real exchange rate (ø) is
going to increase (appreciation
of the real exchange rate) = 
prices of foreign goods 
expressed in home currency 
are higher than prices of 
home goods = foreign goods is
more expensive than home goods
= decreased of imports, 
increasing of exports = 
improve the BT (balance of 
trade) = increased Y = 
increased Employment 


So the equilibrium of 
employment is going to 
shift to the right from 
point D to point B, 
which is our medium run 
equilibrium of employment.

At the end = higher employment
(E1) and a higher wages (w2).