It was easier for rms to layo workers than adjust

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Unformatted text preview: ms to layoff workers than adjust prices and wages. During recessions in was common to observe an excess supply of goods and workers. Firms would responds to decreases in demand by cutting production or increases in demand by expanding production. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 5 / 43 Keynes Menu Costs Menu Costs Keynes argued it was costly to change prices. Firms need to estimate the optimal prices which took time and proved to be costly. Firms wanted to be sure the change in demand was permanent. Workers disliked wage cuts. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 6 / 43 PAE Introduction In the Keynesian model firms respond to changes in demand through production, which meant the primary determinant of output is spending. The more spending that occurs results in greater production and vice versa. Planned aggregate expenditures (PAE) is total planned spending on final goods and services. (PAE) include household consumption (C), investment (I), government spending (G), and net exports (NX). Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 7 / 43 PAE Investment Investment Keynes’ model is fairly simple, firms must decide on how much to produce at the beginning of the period and then observe sales throughout the period. If spending differs from production firms will adjust output the following period. The difference between spending and production will show up in a firms inventories (which is a component of investment). To understand the difference between spending and production we must define plan and realized investment. Ryan W. Herzog (GU) Aggregate Expenditures February 25, 2014 8 / 43 PAE Investment Investment cont. At the beginning of the period firms must predict their level of production and capital investment. This is called...
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This document was uploaded on 03/18/2014 for the course ECON 202 at Gonzaga.

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