Question

Potential GDP Price Level SRAS 115 100 90 AD RGDP in trillions 15 17 What are the three theories that are used to explain the upward sloping SRAS? a. b. What changes would you make to the graph above to show that there was stagflation? What would these changes signify in terms of employment and prices? c. What changes would you make to the graph above to show what happened to the U.S. economy during 2008 and 2009? Why?

Answer 1

The misperceptions theory says lower prices gives wrong impression to suppliers about relative prices so that they reduce output. The sticky wage theory says that wages don't fall for some time as price falls. This means real wages rise which force producers to reduce output. The sticky price theory says that prices of some firms don't fall immediately as prices fall due to their sticky nature. Hence producers reduce output as they face less demand

2 SRAS shifts leftwards to SRASo. As a result prices and unemployment rise. See fig

3 AD fell to ADo so that there was shortage of demand which reduced output and prices