Chapter 14.1 - Basic Theory of Aggregate Supply

Question 1

What are the 3 models of aggregate supply in the short-run?

Answer 1

> Sticky-Wage Model
Sticky-Price Model
Imperfect-information Model

Question 2

What assumption is made for the sticky-wage model?

Answer 2

Firms & workers negotiate contracts & fix the nominal wage before they know what the price level will be.

Question 3

What nominal wage is set in the sticky-wage model?

Answer 3

ω = w/EP

Question 4

Why do firms not change their prices often?

Answer 4

> Long-term contract between customers and firm
Menu Costs
Firms don’t want to annoy customers with frequent price changes. Change prices only if revenue increases.

Question 5

What are some issues with the sticky-wage model?

Answer 5

1. Assumption that workers and firms negotiate contracts (fix nominal wage) before they know the price level.
2. Increase in price level shown to decrease real wage (workers dislike economic booms). Thus, real wage is shown to be counter-cyclical. Not true in the real world.