718PART TWELVESHORT-RUN ECONOMIC FLUCTUATIONSTo see the implications of sticky prices for aggregate supply, suppose that eachfirm in the economy announces its prices in advance based on the economic con-ditions it expects to prevail. Then, after prices are announced, the economy expe-riences an unexpected contraction in the money supply, which (as we havelearned) will reduce the overall price level in the long run. Although some firmsreduce their prices immediately in response to changing economic conditions,other firms may not want to incur additional menu costs and, therefore, may tem-porarily lag behind. Because these lagging firms have prices that are too high, theirsales decline. Declining sales, in turn, cause these firms to cut back on productionand employment. In other words, because not all prices adjust instantly to changingconditions, an unexpected fall in the price level leaves some firms with higher-than-desired
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This note was uploaded on 07/30/2010 for the course ECON 120 taught by Professor Abijian during the Spring '10 term at Mesa CC.