The firm needs to expand production, so it needs more steel. Under the agreement made earlier by the two firms, the steel company would meet this higher demand and sell more steel without raising its price to the automobile company. As a result, the production of steel is totally determined in the short run by the demand from automobile producers, not by price. But what if the firm discovered that it had produced an unpopular car and needed to cut back on its planned production? The firm would require less steel. Under the agreement, the steelmaker would supply less steel but not reduce its price.
Again, demand not price determines steel production in the short run. Similar agreements between firms, both formal and informal, exist throughout the economy. Typically, in the short run, firms will meet changes in the demand for their products by adjusting production with only small changes in the prices they charge their customers. What we have just illustrated for an input such as steel applies to workers, too, who are also inputs to production. Suppose the automobile firm hires union workers under a contract that fixes their wages for a specific period.
If the economy suddenly thrives at some point during that period, the automobile company will employ all the workers and perhaps require some to work overtime. If the economy stagnates at some point during that period, the firm will lay off some workers, using only part of the union labor force. In either case, wages are sticky they will not change during the period of the contract. Retail prices to consumers, like input prices to producers, are also subject to some stickiness. Economists have used information from mail-order catalogues to document this stickiness.
Retail price stickiness is further evidence that many prices in the economy are simply slow to adjust. Over longer periods of time, prices do change. Suppose the automobile company’s car remains popular for a long time. The steel company and the automobile company will adjust the price of steel on their contract to reflect this increased demand. These price adjustments occur only over long periods. In the short run, demand, not prices, determines output, and prices are slow to adjust. Reference link: http://classof1. com/homework-help/economics-homework-help