Natia Tsikvadze

Homework 2

Chapter 3

1) Generally as labor increases the level of output increases too, however the increase rate is
diminishing. At first when labor is relatively small and the number of working places is
relatively high the benefits of increasing labor are great, but then, when labor amount is quite
high and industries and firms have plenty of labors to work with, little benefit is gained from
expanding labor further. In this case firms have more labor on hand than is needed to produce
current level of output. That is why during recessions firms use their workforce less intensively.
This is why labor productivity is procyclical – this means that output per worker declines during
recession. Decrease in labor demanded decreases real wages, so that is why real wages are also
procyclical.

2) The labor supply curve is generally upward sloping because an increase in the current real
wage leads to an increase in the amount of labor supplied. As wages in one industry rise relative
to wages in other industries workers shift their labor to relatively high-wage one.

3) Any factor that increases the amount of labor supplied at given level of the real wage shifts
labor supply curve to the right. These factors can be increase in working age – more people
working means more labor supplied. Participation rate also shifts the curve to the right –
increased number of people wanting to work increases the labor supply. Another factor might be
the decrease of the value of leisure – people will work more so labor supply will increase.
Decline in consumption taxes – consumption will be cheaper, people will decrease the leisure
time and increase labor supply.

4) Because of technological changes productivity of skilled workers increased, however

productivity of unskilled workers decreased and therefore the gap between the wages of these
two types of workers has increased. In case of skilled workers demand curve has gone up and
real wage has increased, but in case of unskilled workers the curve shifts down and lowers real
wage.

Chapter 4

1) Because for the saver the increase in the real interest rate tends to increase savings through
substitution effect and decrease savings through income effect. And without any additional
information it is hard to say which effect dominates.

2) The increase in government consumption affects the desired national savings: S = Y – C –G, it
has direct effect by increasing G and indirect effect by decreasing desired consumption – C. And
if the decline in desired consumption is less than the initial increase in government purchases, a
temporary increase in government purchases will decrease the level of desired national savings.

Real Business Cycle models:

1) Main advantage of RBC model is that it is consistent with many of the basic business cycle
facts : it correctly predicts the recurrent fluctuations in aggregated output, it correctly predicts
that employment will move procyclically, also it predicts that real wages will be higher during
booms than during recessions and it predicts that labor productivity is procyclical too. But there
are four main concerns about this theory: first – technological shocks: usually it is difficult to
identify specific innovations associated with large quarter-to-quarter swings. Second –
intertemporal substitution in labor supply. Third – omission of monetary disturbance: this means
that model omits one source of output movement. Forth: model has no significant propagation
mechanism: the dynamics of output follow the dynamics of the shocks quite closely.

2)