1. Consider labor market in an economy. In a classical model, you can think that each worker comes with one unit of effort. In a Keynesian model effort makes a difference. Suppose that the efficiency wage is above labor market equilibrium. (a) Draw a graph where you can show both employment and unemployment predicted by each model. Discuss unemployment under both models. (b) Now suppose a negative productivity shock hits the economy. How would employment and unemployment change under both Classical and Keynesian model. Show your results on a graph. (c) When the economy is hit by a negative productivity shock, workers are worried about their jobs and they start working harder, that is they increase their effort from two to three. (Note that in the Classical model this is not possible. their effort level is still unity.) How would this affect employment, unemployment and output in the Keynesian model? (d) This time, suppose there is a positive productivity shock. Draw a graph and show new equilibrium both in Classical and Keynesian model. What will be the the employment and unemployment in both models? (e) When the economy is hit by a positive productivity shock, workers think that they can reduce their effort. How would your answers do change in the Keynesian model?
1. Consider labor market in an economy. In a classical model, you can think that each worker comes with one unit of effort. In a Keynesian model effort makes a difference. Suppose that the efficiency wage is above labor market equilibrium. (a) Draw a graph where you can show both employment and unemployment predicted by each model. Discuss unemployment under both models. (b) Now suppose a negative productivity shock hits the economy. How would employment and unemployment change under both Classical and Keynesian model. Show your results on a graph. (c) When the economy is hit by a negative productivity shock, workers are worried about their jobs and they start working harder, that is they increase their effort from two to three. (Note that in the Classical model this is not possible. their effort level is still unity.) How would this affect employment, unemployment and output in the Keynesian model? (d) This time, suppose there is a positive productivity shock. Draw a graph and show new equilibrium both in Classical and Keynesian model. What will be the the employment and unemployment in both models? (e) When the economy is hit by a positive productivity shock, workers think that they can reduce their effort. How would your answers do change in the Keynesian model?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:1. Consider labor market in an economy. In a classical model, you can think that each worker comes with one unit
of effort. In a Keynesian model effort makes a difference. Suppose that the efficiency wage is above labor market
equilibrium.
(a) Draw a graph where you can show both employment and unemployment predicted by each model. Discuss
unemployment under both models.
(b) Now suppose a negative productivity shock hits the economy. How would employment and unemployment
change under both Classical and Keynesian model. Show your results on a graph.
(c) When the economy is hit by a negative productivity shock, workers are worried about their jobs and they
start working harder, that is they increase their effort from two to three. (Note that in the Classical model
this is not possible. their effort level is still unity.) How would this affect employment, unemployment and
output in the Keynesian model?
(d) This time, suppose there is a positive productivity shock. Draw a graph and show new equilibrium both in
Classical and Keynesian model. What will be the the employment and unemployment in both models?
(e) When the economy is hit by a positive productivity shock, workers think that they can reduce their effort.
How would your answers do change in the Keynesian model?
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