Question

QUESTION 2 In the 'simple sticky price New Keynesian Model', an increase in A shifts the AS curve up. O True O False

Answer 1

In simple Keynesian sticky price model, the wages and price are remaining constant during short period. The simple Keynesian model explains a stage of underemployment of resources. In this stage diverting the unemployed resources into productive channel does not create any inflation. The prices and wages are rigid in this situation. The workers and resources owners are working with their fixed wages on their earlier contracts and firms do not change their prices as it disturbs their market demand. Thus an increase in aggregate demand only leads to an increased production and employment. The increase in aggregate expenditure does not increase price and wages. Since the price and wages remain constant the aggregate supply does not shift to the left up because the cost of production does not increase with the increased production. Price P4 Classical range AD4 ----- -- Intermediate range - - L------- P1 - D3 Keynesian range ADI AD2 AD YOYi Y2 Yf GDP a) In the above figure the potential output is Yf. The Keynesian range represents a stage of recession. In this range shifts in the AD curve to the right from AD to AD1 does not increase the price level from 'P'. The output increase from YO to Y1, the employment increase but no effect on price level. There exists an output gap equal to YO-Y1. Since the resources remain unemployed an increase in demand for these resources does not increase their prices and as such the cost of production does not increase . So the AS curve does not shift to the left up. Answer: False.