In situations of sticky prices and negative demand shocks, we would expect firms to

Question

Multiple Choice
deplete inventories before increasing production.
reduce production before building up inventories.
build up inventories before reducing production.
lower prices before reducing production or building up inventories.

Answer 1

In situations of sticky prices and negative demand shocks, we would expect firms to build up inventories before reducing production.

When prices are sticky, firms cannot immediately adjust their prices down in response to decreased demand. This means that they might continue to produce at the same level, leading to an increase in inventories. Eventually, if the demand does not recover, they may need to consider reducing production.