Question

What does “wage and price stickiness” mean? What is its significance in Keynesian analysis?

Answer 1

Wage and price stickiness is an assumption used under economic theory to explain the shape of the aggregate supply curve. When wages and prices are said to be sticky, it indicates that they will not change frequently or adjust in order to bring equilibrium in the market.

Wages are sticky because labour contracts are revised before a specific period and during this period nominal wages remain the same. Prices are also not changed frequently because formsy are concerned about the market sales and there is a cost involved in displaying the price changes which includes menu costs.

In keynesian analysis, because wages and prices are sticky in the short run, the aggregate supply curve is horizontal which means that any change in the aggregate demand will only affect the real GDP and the price level will not change. This is important because under classical economic theory, prices are considered to be flexible and due to this reason aggregate supply is vertical. any change in the aggregate demand will only affect the price level and will leave the real GDP unchanged in classical theory.