In other cases, the price may be set above the equilibrium price – leading to excess supply and a surplus. Price above equilibrium. Real prices … d. it is drawn holding price level constant. Around 15% of wage changes are wage cuts, around 40% of price changes are price cuts. There is a surplus of Q3-Q2. Though, prices do tend to be more flexible than wages. However, because of sticky wages and prices, the wage remains at its original level (W 0) for a period of time and the price remains at its original level (P 0). Although this theory explains the problem of unemployment yet does not explain why nominal wage is slow to change. The price level, in turn, depended on money-wage bargains made between many different groups of workers and employers across the economy as a whole. Assume that at this initial point, the growth rate of the money supply is 5%, the growth rate of the velocity of money is 0% and inflation is 1%. By combining stickiness with problems of co­ordinating, this theory can explain the cause of wage stickiness. Because wages and prices are sticky and because the economy gets stuck, Keynes said that the government needed to step in and do something to help the economy out. This causes the growth rate of consumption and the growth rate of investment to fall. Assume that wages and prices are sticky and that we start at a long-run equilibrium. New Keynesian Economics is a modern twist on the macroeconomic doctrine that evolved from classical Keynesian economics principles. Economists argued that prices and wages are “sticky… As well as wages being sticky, prices can be sticky. To see how nominal wage and price stickiness can cause real GDP to be either above or below potential in the short run, consider the response of the economy to a change in aggregate demand. This study found wage stickiness is more pronounced than price stickiness. Unformatted text preview: Question 1 All of the following statements are true about the short-run aggregate supply curve except Select one: a. it is a graphical representation of the relationship between production and the price level.b. Money illusion is an economic theory stating that many people have an illusory picture of their wealth and income based on nominal dollar terms, rather than real terms. c. it is upward-sloping. Sticky prices are prices that do not adjust immediately to changing economic conditions. Empirical evidence on the extent, causes and consequences of wage rigidity on the individual level is relatively scant, however. At a price of P2, the supply is greater than demand, meaning firms have excess stock they cannot sell. Wage rigidity – the observation that wages cannot be adjusted downwards – has important implica-tions for labour markets and macroeconomic performance. 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