lecture8 - Lecture VIII 1. Return logs Economics 202A Fall...

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1 Lecture VIII Economics 202A Fall 2007 1. Return logs 2. Date of Mid-term: Tuesday, October 23. Last time we looked at efficiency wage models, and especially at Shapiro and Stiglitz, which is the most popular version of such models. Let me briefly make one criticism. My major criticism of those models is that I am fairly sure that in most jobs supervisors do have some fairly good notion regarding what workers do and do not do. For example, absenteeism is directly observable. concepts of the fair wage, which for some people will exceed market clearing. Following the presidential address to the AEA, workers will think that their employers should pay them a fair wage. Today I am going to discuss a problem with efficiency wage models. A major problem with the standard efficiency wage models, such as Shapiro and Stiglitz, is that they are real models of unemployment. One can therefore ask the question whether they have anything to say about cyclical fluctuations. Equivalently, we could ask whether these models have anything to say about the effectiveness of monetary policy. What do I mean by saying that they are real models of unemployment? I mean that all the variables in these models are real variables. There are no nominal variables. Presumably if one added money to such models, it would be neutral. In that case, for example, a 5% increase in the money supply would just change nominal wages and prices by 5 %, and all real variables would be unchanged. Do these models then explain why a shift in aggregate demand, as exemplified by a shift in the money supply, will change any equilibrium real variables? This, of course, is the essence of the problem posed by Robert Lucas at the very beginning of this course.
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2 Insofar as changes in the money supply are expected, why should they cause any change in equilibrium output? Prices and wages should be proportional to the money supply with no changes in real variables. With efficiency wage models, and with most other models, it turns out that there is a simple and easy answer to the question why changes in money might have significant effects on equilibrium output and employment. Because, in a large number of models, wage and price inertia will have little effect on firms& profits, but wage and price inertia will have significant effect on output and employment. To see the innovation in the new models relative to the old, let us review what happens in the old model of the standard Keynesian textbooks. In the simplest such model there is an IS curve and an LM curve, which together determine aggregate demand. Aggregate supply is determined by the condition that firms hire workers up to the point where the Marginal Product of Labor is equal to the real wage. And
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This note was uploaded on 08/01/2008 for the course ECON 202A taught by Professor Akerlof during the Fall '07 term at University of California, Berkeley.

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lecture8 - Lecture VIII 1. Return logs Economics 202A Fall...

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