Question

What are the three premises the short run model is based on? Explain.

Answer 1

Ans - The 3 premises on which short run model is based on are -

1)There is a continuous hit to economy by economic shocks. Economic shocks can be in any form like fluctuations in the prices of oil, technology or spending that results in change in output or causes inflation.

2) The output is affected by the monetary policies as well as fiscal policies of the economy. The policy makers may have the ability to neutralize the effects of shocks on the economy.

3) The trading between inflation and output is of dynamic nature.The government didn't wish to have real GDP at the possible highest value because a flourishing economy results in rise in rate of inflation and in case inflation rate is high , there is a need of recession to lower the inflation. The Phillips curve is the trading between inflation and output dynamically.