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Chapter 17: Q. 15 (page 395)

The policy relevance of new Keynesian inflation dynamics based on the theory of small menu costs and sticky prices depends on the exploitability of the implied relationship between inflation and real GDP. Explain in your own words why the average time between price adjustments by firms is a crucial determinant of whether policymakers can actively exploit this relationship to try to stabilize real GDP.

Short Answer

Expert verified

There would be a brief run trade-off between real GDP and inflation

Step by step solution

01

Given Information 

Its exploitability of inferred link among price and economic GDP is crucial to a notion of little menu costs and sticking price.

02

Explanation

  • Considering the policy relevance of recent Keynesian inflation dynamics, initially there's slow adjustment of the worth level in response to the increased aggregate demand followed by later higher inflation.
  • If the everyday time between price adjustments by firms is critical, then within the short run aggregate supply curve would be considered as horizontal, as hypothesized by the new Keynesian theorists.
  • As a result, there would bea brief run trade-off between real GDP and inflation.

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Most popular questions from this chapter


Both the traditional Keynesian theory discussed in a previous chapter and the new Keynesian theory considered in this chapter indicate that the short-run aggregate supply curve is horizontal.

a. In terms of their short-ran implications for the price level and real GDP , is there any difference between the two approaches?

b. In terms of their long-ran implications for the price level and real GDP, is there any difference between the two approaches?

According to the quantity equation, how else besides using interestrate-based policies might central banks be able to generate higher inflation if they really wished to do so?

Consider Figure 17-5, and suppose that the economy initially operates at point A, at which the inflation rate is 0percent and the unemployment rate is 6percent, which is the natural rate of unemployment. In the long run, will an increase in the inflation rate to 3percent result in the economy operating at point Bor at point F1? Explain your reasoning.

Consider the diagram below, which is drawn under the assumption that the new Keynesian sticky-price theory of aggregate supply applies. Assume that at present, the economy is in long-run equilibrium at point A. Answer the following questions.

a. Suppose that there is a sudden increase in desired investment expenditures. Which of the alternative aggregate demand curves- AD2or AD3-will apply after this event occurs? Other things being equal, what will happen to the equilibrium price level and to equilibrium real GDP in the short ran? Explain.

b. Other things being equal, after the event and adjustments discussed in part (a) have taken place, what will happen to the equilibrium price level and to equilibrium real GDP in the long run? Explain.

Describe an inverse relationship between inflation and unemployment.
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