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effects of the increase in the expected future MPK on current output and prices from AD-AS diagram

1. Output, total hours worked, and average labor productivity all are procyclical.

a) Which variable, output, or total hours worked, increases by a large percentage in expansions and falls by a larger percentage in recessions? (Hint: Average labor productivity = output / total hours worked, so that the percentage change in average labor productivity equals the percentage change in output minus the percentage change in total hours worked)

b) How is the procyclical behavior of average labor productivity related to Okun's Law?

2. Use the IS-LM model to determine the effects of each of the following on the general equilibrium values of the real wage, employment, output, real interest rate, consumption, investment, and price level.

a) A reduction in the effective tax rate on capital increases desired investment.

b) The expected rate of inflation rises.

c) An influx of working-age immigrants increase labor supply (ignore any other possible effects of increased population).

d) The introduction of automatic teller machines reduces the demand for money.

3. Suppose that the price level is fixed in the short run so that the economy doesn't reach general equilibrium immediately after a change in thee economy. For each of the following changes, what are the short-run effects on the real interest rate and output? Assume that, when the economy is in disequilibrium, only the labor market is out of equilibrium; assume also that for a short period, firms are willing to produce enough output to meet the aggregate demand for output.

a) A decrease in the expected rate of inflation.

b) An increase in consumer optimism that increases desired consumption at each level of income and the real interest rate.

c) An increase in government purchases.

d) An increase in lump-sum taxes, with no change in government purchase (consider both the case in which Ricardian equivalence holds and the case in which it doesn't).

e) A scientific breakthrough that increase the expected future MPK.

4. The discovery of a new technology increases the expected future marginal product of capital.

a) Use the classical IS-LM model to determine the effect of the increase in the expected future MPK on current output, the real interest rate, employment, real wages, consumption, investment, and the price level. Assume that expected future real wages and future incomes are unaffected by the new technology. Assume also that current productivity is unaffected.

b) Find the effects of the increase in the expected future MPK on current output and prices from AD-AS diagram based on the misperceptions theory. What accounts for the difference with part (a)?

Solution Summary

IS-LM model is incorporated.