Persistent negative technology shocks in Keynesian Economics

II) Persistent Negative Technology Shocks in Keynesian Economies In this problem you will analyze the effects of a persistent negative technology shock in a Keynesian sticky nominal wage economy. Assume to this end that both z and z' decline, but z by more. Also assume that the economy starts out at a situation of labor market equilibrium. Hint 1: you may use the same diagram in 1) and 3) to 5), as long as you make clear, which curve is which. Different colors may be useful. Hint 2: unless otherwise stated, explanations for shifts in curves or changes in variables can be simple "arrow chains", like: "X1-YZ curve rightward" or "X1-Y!". 1) Show the IS-LM- and AD-AS diagram for a Keynesian sticky wage model. Make sure to annotate axes and curves; make the two diagrams consistent, which is best achieved by drawing the AD-AS diagram below the IS-LM diagram. 2) We first focus on the labor market diagram. Illustrate the first round effects of a persistent negative technology shock there. Recall that first-round in a Keynesian sticky nominal wage context means: for a given price level. 3) Illustrate the first round effect of these shocks in the IS-LM diagram and explain. 4) Show what happens in the AD-AS diagram of this economy (still the first round effects). Make the changes quantitatively consistent with the IS-LM diagram, whenever possible. Assume that the price level effect and the real interest rate effect are ultimately determined by the change in aggregate supply. 5) Show and explain the second-round effect that makes the IS-LM and the AD-AS diagram eventually compatible. 6) Assume that the overall effect on the labor market is that aggregate employment declines and unemployment increases. What is the total effect on output, the price level, the real wage and the real interest rate? Can you say anything definitive about investment and consumption? 7) Which of the following things can the government do to bring the economy out of its predicament (multiple answers may be correct): a) increase government spending; b) increase money supply; c) invest in research and development and thus increase z'. Explain. Should the government act? Explain