For example, the sticky price theory asserts that output prices of some goods and services adjust slowly to changes in the price level. suppose that firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. additionally, assume that many of the firms sell their goods through catalogs and face high costs of reprinting if they change prices. now suppose that the actual price level turns out to be 90 (that is, prices in the economy are lower than expected). faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. sales from catalogs will, and firms that rely on catalogs will respond by the quantity of output they supply. if enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to the natural rate of output in the short run.

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Business

Parker Bridges

14 July, 19:17

For example, the sticky price theory asserts that output prices of some goods and services adjust slowly to changes in the price level. suppose that firms announce the prices for their products in advance, based on an expected price level of 100 for the coming year. additionally, assume that many of the firms sell their goods through catalogs and face high costs of reprinting if they change prices. now suppose that the actual price level turns out to be 90 (that is, prices in the economy are lower than expected). faced with high menu costs, the firms that rely on catalog sales choose not to adjust their prices. sales from catalogs will, and firms that rely on catalogs will respond by the quantity of output they supply. if enough firms face high costs of adjusting prices, the unexpected decrease in the price level causes the quantity of output supplied to the natural rate of output in the short run.

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Paulina Mckay · Answer 1

This is a rare occurence in the market world and can lead to malfuunctions. Since the price level has dropped, we have that the catalogued items are overpriced with respect to the income and other basic goods. Hence, the demand for them will drop. In response, companies will also reduce their output.

Also, we have that the true rate of output and natural rate of output difference is proportional to the diffeerence between price levels. Since the actual price level is lower than the expected one, we have that the rate of output will fall below the natural rate of output for a while.