ECON 305 Chapter Notes -Nominal Rigidity, Aggregate Supply, Market Clearing
11 Mar 2014
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P= price level: output deviates from its natural level when the price level deviates from the expected price level. Sticky price model: emphasizes the slow adjustment of the prices of goods and services. Firms so not instantly adjust prices to change in demand: long term contracts, loyal customers, costs to alter prices, sticky wages. The firm"s price depends on : overall level of prices (p) Higher price level means costs are higher: level of aggregate income y. Higher level of income raises demand for the product. Means increased production and higher prices p=p+a(y y ) The desired price (p) depends on the overall level of prices (p) and on the level of aggregate output relative to the natural level a measures how much the firm"s desired price responds to the level of aggregate output. Firms with sticky prices set their prices based on p = ep.
