Question

5. Problems and Applications Q6

Consider the three theories of the upward slope of the short-run aggregate-supply curve.

According to the sticky-wage theory, the economy is in a recession because the price level has declined so that labor demand is too .

True or False: According to the sticky-price theory, the economy is in a recession because not all prices adjust quickly.

True

False

According to the misperceptions theory, the economy is in a recession when suppliers mistakenly believe that the relative price of their goods has .

Answer 1

True -According to sticky wage theory the pay of employees tends to have a slow response to the changes in the performance of a company or the economy. Specifically wages are often said to be sticky- down, meaning that they can move up easily but move down only with difficulty. Without stickiness, wages would always adjust in more or less real-time with the market and bring about constant economic equilibrium.

In sticky wage theory when Demand for the goods will fall businesses want to sell less, rational individual firms cut prices in response to the fall in demand. But if firms cut their prices while keeping workers wage fixed, firms find workers more expensive. When labors become expensive the demand for labor reduces. Because workers a key input become more expensive, firms rationally decide to produce less. If the price of key input rises you are quite likely to produce less output and demand less of that input.

True- Sticky Price Theory : The rationale behind sticky price theory is the same as sticky wage theory but with regards to the price of goods. Menu costs create stickiness in prices because of the cost and time required to change the price, such as costs of printing new sales materials and distributing catalogs and the time required for a retailer to change price tags. Businesses will temporarily reduce the quantity supplied until they can get prices unstuck.

True- Misperception theory : This theory holds changes in the overall price level temporarily mislead the suppliers about what is happening in the markets in which they sell their goods. They  make an erroneous assumption that their relative prices have also declined. This misperception tends to induce sellers to supply less quantity to the market.

All the above cases are true when the demand reduces due to various reasons and when the supply reduces the total out put decreases and when the total output deceases the GDP contracts. When the GDP contracts the country is expected to be experiencing a recession.