Chapter 12 Keynesian Business Cycle Theory: Sticky Wages and Prices

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. Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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

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

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

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

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

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

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

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

Figure 12.10 A Positive Shift in Money Demand Shifts the LM Curve to the Left Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.11 The Aggregate Demand Curve Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.12 A Shift to the Right in the IS Curve Shifts the AD Curve to the Right Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.13 A Shift to the Right in the LM Curve Shifts the AD Curve to the Right Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.14 The Keynesian Sticky Wage Model 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. Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.15 An Increase in the Money Supply in the Sticky Wage Model Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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

Figure 12.16 Percentage Deviations from Trend in the Money Supply and Real GDP for the Period 1959–2006 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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

Figure 12.17 Real and Nominal Interest Rates, 1934–2006 Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.18 An Increase in the Demand for Investment Goods in the Sticky Wage Model Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.19 Long-Run Adjustment of the Nominal Wage 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. Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.20 Stabilization Policy in the Sticky Wage Model–Monetary Policy Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.21 Stabilization Policy in the Sticky Wage Model–Fiscal Policy 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. Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.22 The Keynesian Sticky Price Model 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: Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

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

Figure 12.23 Determination of Employment in the Sticky Price Model Copyright © 2008 Pearson Addison-Wesley. All rights reserved.

Figure 12.24 The Effect of an Increase in Total Factor Productivity on Employment in the Sticky Wage Model Copyright © 2008 Pearson Addison-Wesley. All rights reserved.