Syndicate
Going Back To Y* With or Without Government Intervention
In order to avoid problems in the prices, the government can use the monetary and fiscal stimulus to increase added demand. However, what happens if the government does not act to stimulate added demand? If the economy is in trouble and the government does not intervene, what would occur? In such cases, the prices will finally go down because the costs of production of the companies will finally diminish as well.
Labor costs diminish very slowly because the administrators do not want to risk alienating the workers by reducing their salaries. But since there are so many unemployed workers when the economy is in a point B, the salaries end up reducing, finally. Some companies hire unemployed workers with lower salaries, which reduces costs and allows them to sell at lower prices than the companies that maintain their high salaries. With time, these competitive pressures mean all of the companies will lower their salaries.
Other costs also become reduced because during a recession, being that production is so low, a significant amount of the productive capacity of the economy remains idle. There are factories, trucks, train wagons etc all idle. Great amounts of wood, petroleum, iron and other products all remain unused.
The owners of these idle products reduce their prices to try to sell them. As the prices go down, the costs of the companies also go down, which allows them to reduce the prices of sales of their products. As these prices of sale go down, the economy moves back to a level of full employment Y*.