Suppose that there is a permanent increase in total factor productivity (both z

Question

Suppose that there is a permanent increase in total factor productivity (both z and z’ increase). Using the intertemporal model, what are the impacts on the following:

a) Output supply (increase / decrease / indeterminate / no change)?
b) Output demand (increase / decrease / indeterminate / no change)?
c) Output (increase / decrease / indeterminate / no change)?
d) Interest rates (increase / decrease / indeterminate / no change)?
e) Labor supply: Direct effect (increase / decrease / indeterminate / no change)?
f) Labor supply: Interest rate effect (increase / decrease / indeterminate / no change)?
g) Labor demand (increase / decrease / indeterminate / no change)?
h) Employment, assuming direct effects dominate (increase / decrease / indeterminate / no change)?
i) Wages, assuming direct effects dominate (increase / decrease / indeterminate / no change)?

Explanation / Answer

a) Higher TFP means higher productivity and thus output supply would increase.

b) Since higher TFP would mean higher wages, it would lead to a higher output demand in the next period.

c) Due to higher output supply and higher output demand, the total output increases.

d) Since supply and demand both rise, the impact on interest rates will be indeterminate as if supply is greater than higher than inflation will fall leading to lower interest rates. On the other hand, if demand is greater than supply, inflation will be higher leading to higher interest rates.

e) Labour supply would also rise due to higher wages and TFP.

f) Due to higher productivity, labor demand would be higher.

g) Employment would rise if we assume direct effects.

h) Since the TFP rises, wages also rise as now one labor can produce more output.

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