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Unformatted text preview: Chapter 11 Keynesianism: The Macroeconomics of Wage and Price Rigidity Learning Objectives I. Goals of Chapter 11 A) Present the central ideas of Keynesian macroeconomics 1. Wages and prices don’t adjust quickly to restore general equilibrium 2. The economy may be in disequilibrium for long periods of time 3. The government should act to stabilize the economy B) Discuss the potential causes of wage and price rigidity II. Notes to Fourth Edition Users A) The application “Macroeconomic Policy and the Real Interest Rate in the 1980s” has been deleted B) Box 11.2 on “Japanese Macroeconomic Policy in the 1990s” was updated C) The Political Environment box on the Council of Economic Advisers was deleted Teaching Notes I. Real-Wage Rigidity (Sec. 11.1) A) Wage rigidity is important in explaining unemployment 1. In the classical model, unemployment is due to mismatches between workers and firms 2. Keynesians are skeptical, believing that recessions lead to substantial cyclical employment 3. To get a model in which unemployment persists, Keynesian theory posits that the real wage is slow to adjust to equilibrate the labor market B) Some reasons for real-wage rigidity 1. For unemployment to exist, the real wage must exceed the market-clearing wage 2. If the real wage is too high, why don’t firms reduce the wage? a. One possibility is that the minimum wage and labor unions prevent wages from being reduced (1) But most U.S. workers aren’t minimum wage workers, nor are they in unions (2) The minimum wage would explain why the nominal wage is rigid, but not why the real wage is rigid (3) This might be a better explanation in Europe, where unions are far more powerful 210 Abel/Bernanke • Macroeconomics, Fifth Edition b. Another possibility is that a firm may want to pay high wages to get a stable labor force and avoid turnover costs—costs of hiring and training new workers c. A third reason is that workers’ productivity may depend on the wages they’re paid—the efficiency wage model C) The Efficiency Wage Model 1. Workers who feel well treated will work harder and more efficiently (the “carrot”); this is Akerlof’s gift exchange motive 2. Workers who are well paid won’t risk losing their jobs by shirking (the “stick”) 3. Both the gift exchange motive and shirking model imply that a worker’s effort depends on the real wage (Figure 11.1) Figure 11.1 4. The effort curve, plotting effort against the real wage, is S-shaped a. At low levels of the real wage, workers make hardly any effort b. Effort rises as the real wage increases c. As the real wage becomes very high, effort flattens out as it reaches the maximum possible level D) Wage determination in the efficiency wage model 1. Given the effort curve, what determines the real wage firms will pay?...
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