Final answer:
2. Sticky wages and sticky prices increase the impact of an economic downturn on unemployment and recession because they prevent wages and prices from adjusting quickly to balance supply and demand.
Step-by-step explanation:
During an economic downturn, the impact on unemployment and recession is increased by sticky wages and sticky prices. When demand decreases, the ideal economic response would be for wages and prices to decline accordingly to balance the supply and demand. Sticky wages mean that wages do not decrease quickly in response to reduced demand for labor, leading to an excess supply of labor, or unemployment. Similarly, sticky prices in the goods market prevent the prices from dropping quickly in response to lowered demand for products, resulting in excess supply, which can compound the effects of a recession. The inability for wages and prices to adjust rapidly prevents the economy from reaching equilibrium promptly, exacerbating the downturn and increasing unemployment levels.
Let's take the labor market as an example. If demand for labor falls from D0 to D1, but wages remain at Wo instead of decreasing, employers will hire fewer workers (Q1) compared to the original quantity (Qo), thus creating unemployment. In the goods market, if demand for products falls and prices do not adjust, sellers are left with more stock than they can sell, leading to a surplus of goods. These inflexibilities slow down the economic recovery process and can deepen the effects of a recession.