Question

Why do sticky wages and prices increase the impact of an economic downturn on unemployment and recession?

Short answer

The coordination argument is one of the reasons why wages are sticky, according to Keynes. Even if most individuals would be prepared to accept a decrease in their own income in tough economic times if everyone else did as well, a market-oriented economy has no obvious method to implement a plan of coordinated wage reductions, according to this argument.

Step-by-step solution

Concept introduction

When AD fluctuated, Keynes found that prices and wages did not adjust instantly. Instead, they remained "sticky," making it difficult to restore the economy to full employment and potential GDP.

Wage and price stickiness

Sticky wages and prices amplify the effects of economic downturns because when a recession occurs, salaries remain unchanged, causing prices to remain high. Employers can no longer afford to keep workers as a result, and workers lose their employment as a result.