(b) price oner than six months? sical economists argue that using fiscal policy
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Question
(b) price oner than six months? sical economists argue that using fiscal policy to fight a recession doesn't make workers better off. Suppose, however, that the Keynesian model is cor- rect. Relative to a policy of doing nothing, does an increase in government purchases that brings the economy to full employment make workers better off? In answering the question, discuss the effects of the fiscal expansion on the real wage, employment, consumption, and current and future taxes. How does your answer depend on (a) the direct benefits of the government spending program and (b) the speed with which prices adjust in the absence of fiscal stimulus? 4, Clas 5. Some labor economists argue that it is useful to think of the lahor market as being divided into two sec-Explanation / Answer
For this question we first have to believe that the short-run aggregate supply curve is upward sloping reflecting sticky wages and flexible prices while the long run aggregate supply curve is vertical reflecting the potential of the economy which is unchanged for any price level. Now apply the keynesian model. The economy must be below the full employment level for keynesian government spending to have any effect.
An increase in the government purchases under keynesian economics, will shift the aggregate demand curve to the right. In the short run wages are fixed. This implies that as the output increases, with the shift in the AD, the price level increases and the real wage Falls. This however increases the employment and reduces the unemployment level. Consumption is increased because income and GDP has increased.
In the long run as the prices have increased firms will revise the nominal wages at a higher rate so that the real wages are unchanged in the long run. In the absence of any fiscal stimulus, aggregate demand will never reach the full employment equilibrium according to keynesian theory because of perpetual deflation. This implies that economy will not self correct itself.
Therefore on one side real wages will fall in the short run on the other side there will be many workers who will get employment. Hence it is ambiguous whether workers are overall better off
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