Apply the concepts of menu costs and staggered price setting to ...

[Lisaclaire]

Apply the concepts of menu costs and staggered price setting to the labor market.
 
  What will be an ideal response?

Question 2

Assume the economy is in equilibrium where real GDP equals potential GDP, and the economy experiences a negative demand shock.
 
  Describe what happens in the IS-MP model, and explain what policy the Fed could use to keep the inflation rate from changing?

[6ana001]

Answer to Question 1

Wages are likely to be sticky, if it is costly for employers to monitor changes in the labor market, and if frequent wage adjustments have adverse effects on employee behavior. Since workers do not change jobs frequently in pursuit of the highest wage, there is little if any short-term penalty for wage persistence, nor reward for prompt wage adjustment. Even when it seems clear that wage adjustments are warranted, employers might hesitate to raise their labor costs above their competitors', or to lose employees by cutting wages before competitors do so.

Answer to Question 2

The negative demand shock shifts the IS curve to the left, decreasing the inflation rate. The Fed would respond by decreasing the real interest rate, shifting the MP curve down, which raises the inflation rate.

[Lisaclaire]

TYSM

[adammoses97]

Excellent