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Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 12 Keynesian Business Cycle Theory: Sticky Wages and Prices.

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Presentation on theme: "Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 12 Keynesian Business Cycle Theory: Sticky Wages and Prices."— Presentation transcript:

1 Copyright © 2008 Pearson Addison-Wesley. All rights reserved. Chapter 12 Keynesian Business Cycle Theory: Sticky Wages and Prices

2 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Chapter 12 Topics Construction of the Keynesian sticky wage model: labor market, aggregate supply, IS and LM curves, aggregate demand. Nonneutrality of money when wages are sticky. The Role of Government in the sticky wage model. A Keynesian sticky price model.

3 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.1 The Labor Market in the Keynesian Sticky Wage Model

4 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.2 The Labor Market in the Keynesian Sticky Wage Model When There Is Excess Demand

5 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.3 Construction of the Aggregate Supply Curve

6 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.4 The Effect of an Increase in W or a Decrease in z

7 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.5 The IS Curve

8 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.6 Money Demand, Money Supply, and the LM Curve

9 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.7 Determination of r and Y Given P

10 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.8 The Effect of an Increase in the Money Supply on the LM Curve

11 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure 12.9 The Effect of an Increase in the Price Level on the LM Curve

12 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Positive Shift in Money Demand Shifts the LM Curve to the Left

13 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure The Aggregate Demand Curve

14 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Shift to the Right in the IS Curve Shifts the AD Curve to the Right

15 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure A Shift to the Right in the LM Curve Shifts the AD Curve to the Right

16 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure The Keynesian Sticky Wage Model

17 Copyright © 2008 Pearson Addison-Wesley. All rights reserved An Increase in the Money Supply The LM curve and AD curve shift to the right. The real interest rate falls, the price level rises, the real wage falls, firms hire more labor, real output increases, consumption rises, investment rises. Money is not neutral in the short run when nominal wages are sticky.

18 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in the Money Supply in the Sticky Wage Model

19 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Table 12.1 Data vs. Predictions of the Keynesian Sticky Wage Model with Monetary Shocks

20 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Percentage Deviations from Trend in the Money Supply and Real GDP for the Period 1959–2006

21 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Table 12.2 Data vs. Predictions of the Keynesian Sticky Wage Model with Investment Shocks

22 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Real and Nominal Interest Rates, 1934–2006

23 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure An Increase in the Demand for Investment Goods in the Sticky Wage Model

24 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Long-Run Adjustment of the Nominal Wage

25 Copyright © 2008 Pearson Addison-Wesley. All rights reserved The Role of Government Policy in the Sticky Wage Model Keynesian unemployment will be eliminated and economic efficiency restored in the long run when nominal wages adjust to equate supply and demand in the labor market. In the short run, efficiency can be restored through appropriate monetary or fiscal policy in the sticky wage model. Monetary or fiscal policy needs to act quickly enough, and given the right information, to have the predicted effects.

26 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Stabilization Policy in the Sticky Wage Model–Monetary Policy

27 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Stabilization Policy in the Sticky Wage Model–Fiscal Policy

28 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Sticky Price Model Firms do not change their nominal prices in the short run, as this is too costly. If demand rises, then firms satisfy this demand by increasing output.

29 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure The Keynesian Sticky Price Model

30 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 12.1 The quantity of employment N must be consistent with the quantity of output Y and the production function:

31 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Equation 12.2 Employment is then an increasing function of Y/z and K.

32 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure Determination of Employment in the Sticky Price Model

33 Copyright © 2008 Pearson Addison-Wesley. All rights reserved Figure The Effect of an Increase in Total Factor Productivity on Employment in the Sticky Wage Model


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