ECON-1007EL Chapter Notes - Chapter 8: Potential Output, Output Gap, Parsec

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The key(cid:374)esia(cid:374) model"s crucial assu(cid:373)ptio(cid:374): fir(cid:373)s meet de(cid:373)a(cid:374)d at preset. The basic keynesian model is a somewhat simplified model of the economy. It is geared towards showing how an economy suffering from a recessionary gap can raise actual output to the level of. It treats the level of potential output as fixed and assumes zero inflation. potential output. In the short-run, firms meet the demand for their product at preset prices. Firms do not respond to every change in the demand for their products by changing their prices. Instead, they typically set a price for some period and then meet the demand as that price. By meeting the demand, we mean that firms produce just enough to satisfy their customers at the prices that have been set. Menu costs are the costs of changing prices. However, this will not prevent firms from changing their prices indefinitely.

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