Answer to Question #289048 in Macroeconomics for Bedilu

Question

On what market imperfection does the four theories of aggregate supply rely?

Answer 1

Aggregate supply is based on two theories: sticky wage theory and sticky-price theory, both of which are founded on the core belief that prices and wages are sticky, affecting aggregate supply.

According to the sticky wage theory, employee pay increases are more inflexible or stickier, and it takes time for businesses to reap the advantages. As a result, real wage unemployment rises as employers lay off to adjust for higher compensation, impacting aggregate supply.

Similarly, the sticky-price theory states that when product taxes are reduced, prices are not passed on to customers, making it stiff, and therefore higher prices tend to reduce aggregate supply.

Both theories are frequently associated with rigidity principles and how they affect aggregate supply and overall economic growth.