Fixed price assumption
Topic: Aggregate Demand, Income Determination and the Multiplier · NCERT: Class 12, Ch 4 "Determination of Income and Employment"
Meaning
The fixed price assumption says that the price level stays constant while output changes in the short run. It rests on the idea that the economy has unused resources: idle machines, buildings and workers. So the law of diminishing returns (extra output costing more and more to produce) does not apply. Output can rise without any rise in marginal cost, the cost of producing one more unit, and so prices do not rise. This lets output be decided by demand alone. It is also a simplifying assumption, and it is dropped at a later stage when prices are allowed to change.
Example
During a slump, a factory running at half its capacity can produce more with its idle machines and workers. It does not need to charge more.
Don't confuse with
- Price rigidity in inflation analysis: once the economy reaches full employment, the assumption breaks down. Extra demand then raises prices (an inflationary gap), not output.