ECON 200 Problem Set 9 Solutions Fall 2007

# ECON 200 Problem Set 9 Solutions Fall 2007 - Economics 200...

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Economics 200 Macroeconomic Theory Solution to Problem Set 9 Recall that, in the sticky-price model, the curve is given by where is the WVEW T œ T ]  ] = / +Ð"=Ñ = ± ² fraction of ( produced by) fixed price firms. As decreases from unity to zero the curve becomes steeper KHT = but it continues to go through the point . This means that the curve rotates around the point ± ² ] ß T WVEW / 1 ± ² ] ß T = / as decreases as shown in the diagram below. Also shown in that diagram is the shift in the aggregate demand curve from to due to the rise in government spending. H H ! " The short-run response of the economy to this rise depends on the slope of the curve. When all the WVEW firms are fixed-price firms the price level does not change and we observe an increase in equal to Ð= œ "Ñ KHT the rise in aggregate demand – all firms respond to the higher demand only by increasing output. When there are some fixed-price and some flex-price firms, , the short-run response is partly a rise in and !  =  " KHT partly a rise in the price level.

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