Intermediate Macroeconomics - Keynesian Theory by pharmphresh32

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									Intermediate Macroeconomics
               Keynesian Theory




              November 3, 2009




Intermediate Macroeconomics       November 3, 2009   1 / 54
Keynesian Theory




  Keynesian Theory ≈ Wage and Price Rigidity
      Real Wage Rigidity ⇒ helps explain unemployment
      Nominal Stickiness ⇒ helps explain monetary nonneutrality
          Nominal refers to “Nominal Wages” and Prices




               Intermediate Macroeconomics               November 3, 2009   2 / 54
Keynesian Theory




  Keynesian Theory Policy Stance

  Recession is not an optimal response of the market
      It is a disequilibrium situation
           Wages and Prices can’t adjust quick enough to get us to GE
           immediately
      Policy makers can remove the disequilibrium




                Intermediate Macroeconomics              November 3, 2009   3 / 54
Real Wage Rigidity



     Classical model ⇒ unemployment is due to mismatches
     between workers and firms
         Evidence disputes this (we see less search during recessions)



     Keynesian model ⇒ the real wage is slow to adjust to
     equilibrate the labor market
         e.g. If the real wage is too high ⇒ unemployment exists




              Intermediate Macroeconomics                 November 3, 2009   4 / 54
Real Wage Rigidity



  Why would the real wage ever be too high?

  Why wouldn’t firms profit maximize by reducing the real wage?




               Intermediate Macroeconomics          November 3, 2009   5 / 54
Real Wage Rigidity



  Why would the real wage ever be too high?

  Why wouldn’t firms profit maximize by reducing the real wage?
      Minimum wage and labor unions may prevent wages from
      being reduced
          But, there is low union membership in U.S.
          Minimum wage is nominal not real (also, Card study shows
          minimum wage doesn’t cause unemployment)
      Efficiency Wages: Workers’ productivity depends on how
      well they’re paid




               Intermediate Macroeconomics             November 3, 2009   5 / 54
Real Wage Rigidity



  The Efficiency Wage Model

  Higher real wage ⇒ work harder
      Akerlof’s “gift exchange motive”

  Higher real wage ⇒ higher cost of shirking
      The opportunity cost of losing your job rises




                Intermediate Macroeconomics           November 3, 2009   6 / 54
Efficiency Wage




           Intermediate Macroeconomics   November 3, 2009   7 / 54
Real Wage Rigidity



  Given the effort curve, what determines the real wage firms will
  pay?
      To maximize profit, firms choose w that gets the most effort
      from workers for each dollar of w paid
                                   E
           Firms want highest      w

      The wage rate at point B is called the efficiency wage
      w is rigid, as long as the effort curve doesn’t change




                Intermediate Macroeconomics           November 3, 2009   8 / 54
Real Wage Rigidity



  Unemployment in the Efficiency Wage Model

  Look at the Labor Market Equilibrium
      The Keynesian ND curve is the MPN curve at a specific
      effort level (E)
           Any change in E shifts the MPN curve (i.e. ND curve)
      For any E ⇒ there exists efficiency wage (w*) that induces E




                Intermediate Macroeconomics             November 3, 2009   9 / 54
Unemployment in the Efficiency Wage Model




            Intermediate Macroeconomics   November 3, 2009   10 / 54
Real Wage Rigidity



  Efficiency wages can help explain procyclical real wage

      During recessions shirking costs ⇑
      This means firms can lower the wage and not worry about
      losing effort
          Shift up of the effort curve
      This would cause lower wages in recessions




               Intermediate Macroeconomics         November 3, 2009   11 / 54
Real Wage Rigidity




  Efficiency wages and the FE line

      Efficiency wages ⇒ full employment level determined by ND
      curve (MPN) and effort curve
                                            ¯
          Labor Supply (NS) has no effect on Y




               Intermediate Macroeconomics       November 3, 2009   12 / 54
Price Stickiness



  Price stickiness is the tendency of prices to adjust slowly to
  changes in the economy
      The data suggest that money is not neutral, so Keynesians
      reject the classical model (without misperceptions)
      Keynesians developed the idea of price stickiness to explain
      why money isn’t neutral
           An alternative version of the Keynesian model assumes that
           nominal wages are sticky, rather than prices




                Intermediate Macroeconomics              November 3, 2009   13 / 54
Price Stickiness



  Why are prices sticky?

      Most firms have at least some monopoly-type power (they can
      set prices)
           Firm sets nominal price, then adjusts output to match
           demand at that set price
      Firms face costs of adjusting prices: “menu costs”
           Price is adjusted from time to time when demand changes
           significantly




                Intermediate Macroeconomics            November 3, 2009   14 / 54
Price Stickiness

  Empirical evidence on price stickiness: Blinder Study




  Kashyap Study: Catalog prices are sticky as well (but presumably
  have no menu costs)
  Bils and Klenow Study: Average time between price change 4.3
  months


                Intermediate Macroeconomics               November 3, 2009   15 / 54
Price Stickiness


  Keynesian Model ⇒ in the short run, firms produce output given
  the price
      i.e. Firms react to demand at the given price by changing
      their output (i.e. “meeting demand”)

  Increasing output (by raising wage to hire more workers) eats into
  the markup, but still increases profit
      Monopolies inherently charge a markup over marginal cost:
      P = (1 + η)MC
      Also, if there are efficiency wages, firm can Y ⇑ without
      having to raise the wage



                Intermediate Macroeconomics            November 3, 2009   16 / 54
Effective Demand Curve




  Since Y moves in the short-run, in the Keynesian model we need to
  describe the level of N at any given Y

      This is the effective demand curve
      ND(Y)




                Intermediate Macroeconomics          November 3, 2009   17 / 54
Effective Demand Curve




            Intermediate Macroeconomics   November 3, 2009   18 / 54
Monetary policy in the Keynesian IS-LM model




  The Keynesian FE line differs from the classical model in two
  respects

                      ¯
      The Keynesian Y occurs where the efficiency wage line
      intersects ND, not where NS equals ND
      Changes in labor supply don’t affect the FE line in the
      Keynesian model




                Intermediate Macroeconomics          November 3, 2009   19 / 54
Monetary policy in the Keynesian IS-LM model




  Since prices are sticky in the short run, P doesn’t immediately
  adjust to restore GE

      When not in GE, the economy lies at the intersection of the
      IS and LM curves, and may be off the FE line
      This represents the assumption that firms meet the demand
      for their products by adjusting N




                Intermediate Macroeconomics            November 3, 2009   20 / 54
An Increase in the Money Supply




             Intermediate Macroeconomics   November 3, 2009   21 / 54

								
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