Question

Question 4) Consider an economy with two kinds of firms :

• Firms with sticky prices have ??

• Firms with flexible prices ??
  A) Derive the following SRAS that we discussed in the class. You have to explain your steps and

  assumption clearly ( 10 points)

?=?̅ + α (P – EP),
Where α = s/[(1-s)a] , and
s=0.5 is the fraction of firms with sticky prices;
a=0.5 is just a parameter.
?̅= 200
B) How do you interpret the SRAS? ( 5 points)
C) Assume that the AD curve is given as Y= 1000 – 10P, and we are in the long-run equilibrium. Determine the values of Y, P and EP in the equilibrium. (15 points)

D) Suppose that the share of firms with sticky prices increase to s=0.75. What will be the impact of that on your answer in part b? Calculate it? (10 points)

Answer 1

A. A) Firms set their desired prices as: Pf = P + a(y-7) ps = Ep + a (EY-EF) for sticky price firms, they expect to output to be at full employment: .. EY - ET Ps = EP Then the aggregate price level is: p=spt (1-5) ff P: SEP +.(1-5)[p + a(7.7)] ar, [1-148] P = SEP + Cons) a (^-5) sp=s&P + (1-s) a (7-8) a, P. EP+-53a (-8) car, P- EP = 11-53a [4-7] aj (-5) a (P-EP) = Y- ..raj trasya [P-Ep] .:: Y = + a(P-EP) .... SRAS with s= a = 0.5 ; F = 200; ..:: Y = 200 + 05 (Prep) 0:5X0.5 :: Y = 200 + 2 (P-EP) This cwere shows that deviation of output from its natural rate is twice as much the deviation of price level from its expected rate AD: Y = 1000-10P SRAS: Y = 200 + 2 (P-EP). LRAS : Y = 7 : 2 o o . At long run equilibrium: Y=200 . PE 1000-200 = 80 10 iPa EP80 .

0.75 D) Let S : 0.75, :. aa (i-S).a ^ 0.25 x 0.5 - 6 :: SRAS: Y = 200 + 6 (P-EP) However as LRÁS: Y: 200 and P : EP with AD: Y = 1000 - 2010P :: P = Ep = 80 and Y : 200 Then with the answers in (c) does not change change in s...