Suppose that the economy is populated by two types of firms, firms with sticky prices and firms with flexible prices. These firms set their prices according to ps = EP, pf = P + a(Y-Y), where the superscripts and f denotes sticky and flexible price firms. Suppose the fraction of firms with sticky prices is equal to 0, meaning that 1 - 0 firms have flexible prices. Further, let a = 2 and 0 = 0.75. (a) Derive the short-run aggregate supply curve. Suppose that the natural rate of out- put is given by Y 100 and EP = 40. Plot the SRAS for output levels ranging from = 0 to 200. (b) Suppose that new technology reduces the fraction of firms with sticky prices from e=0.5. Is the new short-run aggregate supply curve steeper or flatter than the curve found in (a)? Plot this curve in the same diagram for the same values of P. (c) Suppose Okun's Law obeys a(Y – Ý) -p(u - u") where ß = = 3 and un = 5. Assume that the fraction of sticky price firms remains at = 0.5. Derive and plot this Phillips curve. = (d) Now suppose that expectations are formed adaptively so that Eπ = π_₁ and The Bank of Canada wants to reduce the inflation rate by 2%. What will happen to unemployment and output? What is the sacrifice ratio?²

Suppose that the economy is populated by two types of firms, firms with sticky prices and firms with flexible prices. These firms set their prices according to ps = EP, pf = P + a(Y-Y), where the superscripts and f denotes sticky and flexible price firms. Suppose the fraction of firms with sticky prices is equal to 0, meaning that 1 - 0 firms have flexible prices. Further, let a = 2 and 0 = 0.75. (a) Derive the short-run aggregate supply curve. Suppose that the natural rate of out- put is given by Y 100 and EP = 40. Plot the SRAS for output levels ranging from = 0 to 200. (b) Suppose that new technology reduces the fraction of firms with sticky prices from e=0.5. Is the new short-run aggregate supply curve steeper or flatter than the curve found in (a)? Plot this curve in the same diagram for the same values of P. (c) Suppose Okun's Law obeys a(Y – Ý) -p(u - u") where ß = = 3 and un = 5. Assume that the fraction of sticky price firms remains at = 0.5. Derive and plot this Phillips curve. = (d) Now suppose that expectations are formed adaptively so that Eπ = π_₁ and The Bank of Canada wants to reduce the inflation rate by 2%. What will happen to unemployment and output? What is the sacrifice ratio?²

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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