1. The sticky-wage model If it turns out that then
unemployment and output are at their natural rates
Real wage is less than its target, so firms hire more workers and output rises above its natural rate
Real wage exceeds its target, so firms hire fewer workers and output falls below its natural rate

2. The sticky-wage model
Implies that the real wage should be counter-cyclical , it should move in the opposite direction as output over the course of business cycles:
In booms, when P typically rises, the real wage should fall.
In recessions, when P typically falls, the real wage should rise.
This prediction does not come true in the real world:

3. The cyclical behavior of the real wage
Percentage
change in real 4
1972
wage 3
1998
1965 2
1960
1997
1999 1
1996
2000
1970
1984
1982
1993
1991
1992 -1
1990 -2
1975 -3
1979
1974 -4
1980 -5 -3 -2 -1 1 2 3 4 5 6 7 8
Percentage change in real GDP

4. Small menu costs and aggregate-demand externalities
There are externalities to price adjustment: A price reduction by one firm causes the overall price level to fall (albeit slightly). This raises real money balances and increases aggregate demand, which benefits other firms.
Menu costs are the costs of changing prices (e.g., costs of printing new menus or mailing new catalogs)
In the presence of menu costs, sticky prices may be optimal for the firms setting them even though they are undesirable for the economy as a whole.

5. Recessions as coordination failure
In recessions, output is low, workers are unemployed, and factories sit idle.
If all firms and workers would reduce their prices, then economy would return to full employment.
But, no individual firm or worker would be willing to cut his price without knowing that others will cut their prices. Hence, prices remain high and the recession continues.
The textbook (p.511) shows a game between two firms in which both would be better off if both cut prices, but each is unwilling to cut price first; in the equilibrium, neither cuts its price.

6. Recessions as coordination failure
Firm 1
Firm 2
Keep high price
Cut price
Cut price
Firm 1 makes $30
Firm 2 makes $30
Firm 1 makes $5
Firm 2 makes $15
Keep high price
Firm 1 makes $15
Firm 2 makes $5
Firm 1 makes $15
Firm 2 makes $15
The textbook (p.511) shows a game between two firms in which both would be better off if both cut prices, but each is unwilling to cut price first; in the equilibrium, neither cuts its price.

7. The staggering of wages and prices
All wages and prices do not adjust at the same time.
This staggering of wage & price adjustment causes the overall price level to move slowly in response to demand changes.
Each firm and worker knows that when it reduces its nominal price, its relative price will be low for a time. This makes them reluctant to reduce their price.
The text does not discuss contracts, but contracts may also explain price stickiness:
The cost of negotiating may be sufficiently high that buyers and sellers agree to a contract that fixes the price for the duration of the contract’s life. However, we are trying to explain the stickiness of nominal prices. One wonders why contracts do not specify a real price (i.e., index the nominal price to a measure of the price level), as the elimination of inflation uncertainty would make buyer and seller better off (provided both are risk averse).

8. The staggering of wages and prices
1) Synchronized Price Setting
  Every firm adjusts its price on the first day of every month
May 1
June 1 AD
“boom”
May 10
The text does not discuss contracts, but contracts may also explain price stickiness:
The cost of negotiating may be sufficiently high that buyers and sellers agree to a contract that fixes the price for the duration of the contract’s life. However, we are trying to explain the stickiness of nominal prices. One wonders why contracts do not specify a real price (i.e., index the nominal price to a measure of the price level), as the elimination of inflation uncertainty would make buyer and seller better off (provided both are risk averse).

9. The staggering of wages and prices
2) Staggered Price Setting
  Half the firms set prices on the first day of each month and half on the fifteenth
May 1
June 1 AD
May 10
May 15
Half the firms raise their prices
(But probably raise prices not very much)
The other firms will make little adjustment when their turn comes
The text does not discuss contracts, but contracts may also explain price stickiness:
The cost of negotiating may be sufficiently high that buyers and sellers agree to a contract that fixes the price for the duration of the contract’s life. However, we are trying to explain the stickiness of nominal prices. One wonders why contracts do not specify a real price (i.e., index the nominal price to a measure of the price level), as the elimination of inflation uncertainty would make buyer and seller better off (provided both are risk averse).

10. The staggering of wages and prices
2) Staggered Price Setting
 Price level rises slowly as the result of small price increases on the first and the fifteenth of each month (because no firm wishes to be the first to post a substantial price increase)
The text does not discuss contracts, but contracts may also explain price stickiness:
The cost of negotiating may be sufficiently high that buyers and sellers agree to a contract that fixes the price for the duration of the contract’s life. However, we are trying to explain the stickiness of nominal prices. One wonders why contracts do not specify a real price (i.e., index the nominal price to a measure of the price level), as the elimination of inflation uncertainty would make buyer and seller better off (provided both are risk averse).