[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

control over the price of the goods they produce. But firms face a great deal of uncertainty
about the consequences of price changes. The effect of a lower price on a
firm’s sales depends on how other firms in the industry as well as its customers
respond. If rivals lower their prices, the firm may fail to gain market share, and the
price decline may simply put its profits into a nosedive. If rivals have no reaction,
the firm may gain a competitive advantage. The behavior of customers is also unpredictable.
If they think this is just the first of several price cuts, they may decide to
wait until prices get still lower before they buy. Thus, a decrease in prices might
even result in lower sales.
Often much greater uncertainty is associated with changing prices than with
changing output and employment. When a firm cuts back on production, provided
that the cuts are not too drastic, it risks only depleting its inventories below normal
levels should sales be stronger than expected. If that happens, it can simply increase
production. Thus its added risk is small, as long as production costs do not change
much over time.
Since firms like to avoid risks, they try to avoid making large changes in prices
(and wages, as discussed earlier). They would rather accept somewhat larger changes
in the amount produced and in employment. As a result, prices are sticky.
Wrap-Up
CYCLICAL UNEMPLOYMENT
Cyclical unemployment is typically generated by shifts in the aggregate demand
curve for labor when real wages fail to adjust. These shifts often arise from changes
in aggregate output.
Real wages can fail to adjust because nominal wages and many prices are sticky.
Understanding Macroeconomic
Fluctuations: Key Concepts
We have argued that the full-employment model of Part Six cannot explain cyclical
unemployment. To understand economic fluctuations and how government policies
can affect the economy, economists have developed a basic model that differs from
the long-run, full-employment model in several critical respects. Fortunately for
ease of understanding, the two models also share many features.
Four key ideas are fundamental to helping us understand economic fluctuations.
A brief discussion of each will give an overview of the model of fluctuations, before
each is developed in more detail in the remainder of this chapter and in the chapters
that follow.
The first two fundamental ideas reflect behavior we observe around us—the
slow adjustment of wages and prices. When wages (and prices) have had enough
time to adjust, supply and demand will balance in all markets, including the labor
648 ∂ CHAPTER 29 INTRODUCTION TO MACROECONOMIC FLUCTUATIONS