Explain the menu cost explanation of output fluctuations.

What will be an ideal response?


Each wage setter or price setter is largely indifferent as to when and how often he changes his own wage or price. Therefore, even small costs of changing prices can lead to infrequent and staggered price adjustment. This staggering leads to slow adjustment of the price level and to large aggregate output fluctuations in response to movements in aggregate demand. In short, decisions that do not matter much at the individual level (how often to change prices or wages) lead to large aggregate effects (slow adjustment of the price level, and shifts in aggregate demand that have a large effect on output).