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A Near-Rational Model of the Business Cycle, With Wage and Price Inertia

George A. Akerlof and Janet L. Yellen
The Quarterly Journal of Economics
Vol. 100, Supplement (1985), pp. 823-838
Published by: Oxford University Press
DOI: 10.2307/1882925
Stable URL: http://www.jstor.org/stable/1882925
Page Count: 16
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A Near-Rational Model of the Business Cycle, With Wage and Price Inertia
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Abstract

This paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects. The individual loss to agents with inertial price-wage behavior is second-order in terms of the parameter describing the shock, while the effect on real economic variables is first-order. Thus, significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses.

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