<p>Consider a firm which cannot change its prices in a given period (or equivalently, faces adjustment costs to change their prices). So long as the price is above their marginal cost, then, they will supply whatever quantity is demanded (at the fixed price).</p>
<p>Consequently, the quantity demanded will generally determine the quantity supplied in equilibrium for this firm.</p>

CC BY-SA 4.0
2024-05-04T10:26:31.820Z
2024-05-04T10:26:31.820Z
matthewoulton
<p>Since you say you understand math I will focus only on intuition.</p>
<p>Price rigidities imply that level of prices can have real effect on output, at least in short run. Also generally higher prices will have positive effect on output and lower prices negative effect on output in short run. The exact reason for this depends on nature of nominal rigidities. For example, if there are rigidities in labor market (nominal fixed contracts, or high minimum wages) then increase in price level lowers real cost of labor and allows firms to hire more people and vice versa.</p>
<p>The price level depends on aggregate demand, even if fundamental reason for increase in price level might lie deeper (e.g. money market which is part of IS-LM from which you derive AD), it is the intersection of aggregate demand and supply that determines the price level in New Keynesian models. So you can view it as output being determined by aggregate demand in a sense that if there is more aggregate demand more will be produced in short run.</p>

CC BY-SA 4.0
2023-04-07T11:17:17.330Z
2023-04-07T11:17:17.330Z
1muflon1
<p>First time going through the basic new-keynesian model and i understand the math behind it okay. I also get that output being partly demand determined is the transmission mechanism for monetary policy in the model but im struggling to see through the maths and get intuition to why nominal rigidities cause output to be demand determined.</p>
<p>Thanks in advance for any help.</p>

<macroeconomics><interest-rate><monetary-policy><central-banking><new-keynesian-economics>
Why do sticky prices make output partly determined by demand?
user43884
# Why do sticky prices make output partly determined by demand?

(Asked by: username_0 on 2023-04-07)

First time going through the basic new-keynesian model and i understand the math behind it okay. I also get that output being partly demand determined is the transmission mechanism for monetary policy in the model but im struggling to see through the maths and get intuition to why nominal rigidities cause output to be demand determined.

Thanks in advance for any help.

**Tags:** macroeconomics, interest-rate, monetary-policy, central-banking, new-keynesian-economics


---

## 2 answers

### Answer by username_1 on 2024-05-04. Score: 1

Consider a firm which cannot change its prices in a given period (or equivalently, faces adjustment costs to change their prices). So long as the price is above their marginal cost, then, they will supply whatever quantity is demanded (at the fixed price).

Consequently, the quantity demanded will generally determine the quantity supplied in equilibrium for this firm.


---

### Answer by username_2 on 2023-04-07. Score: 0

Since you say you understand math I will focus only on intuition.

Price rigidities imply that level of prices can have real effect on output, at least in short run. Also generally higher prices will have positive effect on output and lower prices negative effect on output in short run. The exact reason for this depends on nature of nominal rigidities. For example, if there are rigidities in labor market (nominal fixed contracts, or high minimum wages) then increase in price level lowers real cost of labor and allows firms to hire more people and vice versa.

The price level depends on aggregate demand, even if fundamental reason for increase in price level might lie deeper (e.g. money market which is part of IS-LM from which you derive AD), it is the intersection of aggregate demand and supply that determines the price level in New Keynesian models. So you can view it as output being determined by aggregate demand in a sense that if there is more aggregate demand more will be produced in short run.


---

