Chapter 12: Keynesian Business Cycle Analysis

1
Chapter 12 Keynesian Business Cycle Analysis

• Focus
• Why are prices and wages sticky in the short run?
  
• Efficiency Wage, Menu Cost, Monopolistic
  Competition
• What causes business cycle?
• Should government intervene?

2

• Reasons for sticky wages
• Minimum Wage, Unions etc.
• Turnover Cost
• Efficiency Wage
• Basic idea behind efficiency wage is that
  workers productivity depends on wage. Higher the
  wage, more effort a worker puts in and thus
  higher his productivity.

3

• Reasons for positive association between wage and
  effort
• Gift Exchange Motive, Higher Morale
• Shirking (or getting fired) is costly
• Effort curve relates the amount of effort to the
  real wage, and it is upward sloping.
• Efficiency wage is the real wage which maximizes
  the workers effort per unit of real wage.

4

• Reasons for price stickiness
• Monopolistic Competition
• Menu Cost
• With monopolistic competition, a profit
  maximizing firm charges price (P) higher than its
  marginal cost (MC)
• P (1?)MC, where ? is called markup.

5

• According to Keynesian economists, business cycle
  is mainly caused by fluctuations in aggregate
  demand factors which shift IS or LM curves.
• These factors include changes in confidence of
  consumers or businessmen, changes in government
  expenditure, money demand and supply etc.

6

• Predictions of Keynesian model are consistent
  with many business cycle facts.
• The main short-coming of the Keynesian model is
  that it predicts labor productivity to be
  anticyclical, while empirically it has been found
  to be procyclical.
• Labor hoarding tendency of firms to keep more
  workers than necessary during recession can
  generate procyclical labor productivity in
  Keynesian model.