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Consider the economy of Freeland, whose overall actual price index and actual output are P and...

Consider the economy of Freeland, whose overall actual price index and actual output are P and Y respectively, and the natural rate of output is Yˉ . There are two types of firms in Freeland: firms with flexible prices, which set prices according to p = P + 0.5(Y − Yˉ ); and firms with sticky prices, which set prices base on p = Pe (the expected overall price index). Also the fraction of firms with sticky prices is s = 0.75.

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Answer #1

according to the given information, Equilibrium price will consist of the 75% proportion of sticky priced firm and 25% of the flexible priced firm.

P= 0.25Pf + 0.75Ps

Pf = P + 0.5(Y − Yˉ )

Ps= Pe

put these in first equation

P= 0.25(P + 0.5(Y − Yˉ ))+ 0.75(Pe)

On the basis of further information, this equation will be solved

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