| The IS-LM exposition of the Keynesian theory assumed
prices are completely fixed in the short-run. New classical economists
assumed they were flexible. Sticky prices, it was argued, are inconsistent
with microeconomics. After rational expectations, Keynesian economists
were forced to justify their assumption: why would firms fail to adjust
their prices in the face of changes in the macroeconomic environment? The
so-called new Keynesians adotped a theory of price rigidity based on the
concept of menu costs. We look at this theory in this section. |