10-22-09 - ECONOMICS 100B Professor Martha Olney 10/22/09...

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ECONOMICS 100B Professor Martha Olney 10/22/09 Lecture 17 ASUC Lecture Notes Online is the only authorized note-taking service at UC Berkeley. Do not share, copy or illegally distribute (electronically or otherwise) these notes. Our student-run program depends on your individual subscription for its continued existence. These notes are copyrighted by the University of California and are for your personal use only. D O N O T C O P Y Sharing or copying these notes is illegal and could end note taking for this course. ANNOUNCEMENTS A student left a textbook in Vico’s office hours. LECTURE Outline Introduction to Sticky Price Model Determination of Y in Short-Run o PE & AD o Keynesian Cross Output gap and unemployment Y given PE Introduction to the Sticky Price Model Today we are switching gears from the long-run to the short-run. The assumption that distinguishes SR and LR is prices. When we assume prices are sticky, versus fully flexible, then we are in the short-run. This is when output produced can be something other than Y*. Fully flexible prices mean that prices are instantaneously adjusting to changes in supply and demand, such as stock prices. Most of the prices you and I confront on a daily basis are not flexible, even with changes in supply and demand. For example, rent control makes rent not fully flexible. Also, the most your landlord can change your rent rates is once a month. Another example is wage cuts. Currently, we are experiencing pay cuts. But pay cuts are onetime cuts. Wages are not constantly changing. When economists say sticky, we do not mean stuck, but we mean that it changes infrequently. When we have sticky prices, then our total output produced can be different from the full employment amount of output. When we talk about a flexible price model, it is a long-run classical model. Its implication is that output produced is some function of input. ܻ כ ൌ݂ሺܭ,ܮ ൈ ܧሻ The asterisk denotes output at full employment. This is the long-run. With sticky prices, we are talking about the short-run and looking at the Keynesian model of the economy. Actual output can be less than, greater than, or equal to full- employment output of Y*. ܻ כ ൏ൌ൐ ܻ There are many proposed answers to why wages are sticky. My two favorites are the following. One reason could be menu costs. There is a cost associated with changing the prices on menus at a restaurant. You have to print out a new menu each time your restaurant changes its prices. Menu costs are the cost of changing prices. This makes businesses less inclined to change prices constantly. A second reason is the notion that wage cuts are unfair. People do not react well to pay cuts. Employers are hesitant to reduce wages because
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This note was uploaded on 02/04/2011 for the course ECON 100B taught by Professor Wood during the Fall '08 term at University of California, Berkeley.

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10-22-09 - ECONOMICS 100B Professor Martha Olney 10/22/09...

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