Thursday, September 19, 2019
Business Cycle Theory :: essays research papers
The Sticky-Wage Model In this model, economists pursue the sluggish adjustment of nominal wages path to explain why it is that the short-run aggregate supply curve is upward sloping. For sticky nominal wages, an increase in the price level lowers the real wage therefore making labor cheaper for firms. Cheaper labor means that firms will hire more labor, and the increased labor will in turn produce more output. The time period where the nominal wage cannot adjust to the changes in price level and output signifies the positive sloping aggregate supply curve. †¢Ã‚     The nominal wage is set by the workers and the firms based on the target real wage, which may or may not be the labor supply & demand equilibrium, and on price level expectation. W =      à ¹      *           Pe Nominal Wage = Target Real Wage * Expected Price Level After the nominal wage has been set but before any hiring, firms learn the actual price level (P). From this the real wage is derived W/P = à ¹ * Pe/P Real Wage = Target Real Wage * Expected Price Level/Actual Price Level From the equation, real wage = target real wage when expected price level = actual price level real wage > target real wage when expected price level < actual price level real wage < target real wage when expected price level > actual price level The bargaining between workers and firms determine the nominal wage rate but not the actual level of employment. This is determined by the firms’ hiring decisions and the labor demand function L = Ld(W/P) Output is determined by the production function, Y = F(L). The aggregate supply curve, under the sticky-wage model, summarizes the two functions and the relationship between the price level and output. Any unexpected changes in the price level cause a deviation in the real wage, which in turn, affects the amount of labor and output. †¢Ã‚     The major weakness of the sticky-wage model however, is that in any model with an unchanging labor demand curve, unemployment falls when the real wage falls. Under this model the opposite happens, which means that the real wage should be countercyclical. Economic data over the past decades in the U.S. shows that the real wage in fact tends to rise along with output. This is evidence contrary to Keynes predictions in the General Theory. The Imperfect-Information Model Characteristics: †¢Ã‚     Assumes that the market is clear – all wages and prices are free to adjust in order to balance supply and demand – and that differences in the short-run and long-run aggregate supply curves are from misperceptions about prices
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