Many economists believe that some wages and prices are "sticky downward" , meaning that these wages and prices increase quickly when demand is increasing but decrease slowly, if at all, when demand is decreasing. Discuss the consequences of this for the automatic mechanism that brings the economy back to potential GDP after an increase in aggregate demand. Would your answer change if aggregate demand decreased rather than increased? Explain.

Many economists believe that some wages and prices are "sticky downward" , meaning that these wages and prices increase quickly when demand is increasing but decrease slowly, if at all, when demand is decreasing. Discuss the consequences of this for the automatic mechanism that brings the economy back to potential GDP after an increase in aggregate demand. Would your answer change if aggregate demand decreased rather than increased? Explain.

Brief Principles of Macroeconomics (MindTap Course List)

8th Edition

ISBN:9781337091985

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter18: Six Debates Over Macroeconomic Policy

Section: Chapter Questions

Problem 2CQQ

See similar textbooks

Similar questions

When the economy is experiencing a recession, why would aneoclassical e conomist be unlikely toargue for aggressive policy to stimulate aggregate demandand return the economy to full employment? Explain your answer.
In 1939, with the U.S. economy not yet fullyrecovered from the Great Depression, PresidentFranklin Roosevelt proclaimed that Thanksgivingwould fall a week earlier than usual so that theshopping period before Christmas would be longer.(The policy was dubbed “Franksgiving.”) Explainwhat President Roosevelt might have been trying toachieve, using the model of aggregate demand andaggregate supply
Suppose an economy is in long-run equilibrium.a. Use the model of aggregate demand andaggregate supply to illustrate the initialequilibrium (call it point A). Be sure to includeboth short-run aggregate supply and long-runaggregate supply.b. The central bank raises the money supply by5 percent. Use your diagram to show whathappens to output and the price level as theeconomy moves from the initial equilibrium to thenew short-run equilibrium (call it point B).c. Now show the new long-run equilibrium (call itpoint C). What causes the economy to move frompoint B to point C?d. According to the sticky-wage theory of aggregatesupply, how do nominal wages at point Acompare with nominal wages at point B? How donominal wages at point A compare with nominalwages at point C?e. According to the sticky-wage theory of aggregatesupply, how do real wages at point A comparewith real wages at point B? How do real wages atpoint A compare with real wages at point C?f. Judging by the impact of the money…
You are hired by the Council of Economic Advisors (CEA) as an economic consultant.The chairperson of the CEA tells you that she believes the current unemployment rate istoo high. The unemployment rate can be reduced if aggregate output increases. She wantsto know what policy to pursue to increase aggregate output by 300 billion TL. The bestestimate she has for the MPC is 0.8. Which of the following policies should yourecommend?a) Increase government purchases by 75 billion TL.b) Reduce taxes by 75 billion TL.c) Reduce taxes by 75 billion TL and to increase government purchases by 75 billion TL.d) Reduce the budget deficit by 300 billion TL
For each of the three theories for the upward slopeof the short-run aggregate-supply curve, e<~rcfullyexplain the following:tl. how the economy recovers from a recession andreturns to its long-run equilibrium without anypoUcy inrerventionb. what determines the speed of that recovery
Refer to the following figure 1. For this economy, if the actual price level exceeds theexpected price level, how much output will the economyproduce in the short-run? A)$17 trillionB)$17.2 trillionC)$16.7 trillionD) Both A and C.2. Given the situation in part (a), this economy wouldexperience A) a recessionary gap of $0.3 trillionB) an expansionary gap of $0.2 trillionC) neither a recessionary gap nor an expansionary gap.D) an expansionary gap of $17.2 trillion. 3. Given the situation in part (a), in this economy (circlethe letter representing the right answer below)A) the actual rate of unemployment would be less than thenatural rate of unemployment.B) the actual rate of unemployment would be above the naturalrate of unemployment.C) the actual rate of unemployment would be equal to thenatural rate of unemployment.D)none of the above.4. In this economy, given the situation in part (a), in thelong-run (circle the letter representing the right answerbelow)A) the nominal wage…
Suppose the economy is in a long-run equilibrium.a. Draw a diagram to illustrate the state of theeconomy. Be sure to show aggregate demand,short-run aggregate supply, and long-runaggregate supply.b. Now suppose that a stock market crash causesaggregate demand to fall. Use your diagramto show what happens to output and the pricelevel in the short run. What happens to theunemployment rate?c. Use the sticky-wage theory of aggregate supplyto explain what happens to output and the pricelevel in the long run (assuming no change inpolicy). What role does the expected price levelplay in this adjustment? Be sure to illustrate youranalysis in a graph.
On June 5, 2003, the European Central Bank acted to decreasethe short-term interest rate in Europe by half a percentagepoint, to 2 percent. The bank’s president at the time, WillemDuisenberg, suggested that, in the future, the bank could reducerates further. The rate cut was made because European coun-tries were growing very slowly or were in recession. What effectdid the bank hope the action would have on the economy? Bespecific. What was the hoped-for result on C, I, and Y?
1. In the diagram for this exercise, use aggregate demand and short-run and long-run aggregate supply curves to show an economy at a short-run equilibrium with a contrac- tionary gap of $0.5 trillion when potential output is $10 trillion.Then illustrate how the gap would close in the long run if the economy is self-correcting. 2. In the diagram, use aggregate demand and short-run and long-run aggregate supply curves to show an economy at a short-run equilibrium with an expansionary gap of $0.5 trillion when potential output is $10 trillion.Then illus- trate how the gap would close in the long run using an activist approach.
If large budget deficits cause the public to think therewill be higher inflation in the future, what is likely tohappen to the short-run aggregate supply curve whenbudget deficits rise?
An economy is in long-run macroeconomic equilibrium when each of the following aggregate demand shocks occurs. What kind of gap - inflationary or recessionary - will the economy face after the shock, and what type of fiscal policies would help move the economy back to potential output? How would your recommended fiscal policy shift the aggregate demandcurve? (Note: you do not need to draw anything).(a) A stock market boom increases the value of stocks held by households.(b) Firms come to believe that a recession in the near future is likely.(c) Anticipating the possibility of war, the government increases its purchases of military equipment.(d) The quantity of money in the economy declines and interest rates increase.
Congratulationst You have been appointed an economic policy adviser to the United States, You are told that the economy is significantly abowe futtemplyoment GDP. Based on this inlormation, how can the economy would adjust to reach LR.SR Equilbrium (Classical View)? The economy wilt experience low unemployment rate, pushing wages up, and increasing the pelces of a key input (labor). shatting the sAS to the left (up). The economy will experience high unemployment rate, pushing wages down, and reducing the prices of a key input (labor). shiting the SAS to the right (down). The econoriny wil experience low unemployment rate, decreasing inceme, which will eventually shift the AD to the left. The eooncmy will experience low unemployment rate, pushing wages up, and increasing the prices of a key input (labor), shiting the sAs to the night (down).