Question 1:

In this question we will use our short-run labor market model to get a different view on the Corona virus pandemic and its effects on the economy. One way to look at the effects of the crisis is to assume that it affects the demand for goods and services, given that people have lower incomes. Here we make a different assumption and focus entirely on the supply effects. The pandemic caused governments around the world to issue stay-at-home orders and to shut down parts of the economy. Even without the government orders people are less inclined to return to work if physical presence in the work place is necessary and social distancing is difficult, given that they face a higher risk of getting sick. This means at any given wage there is a lower quantity of labor available (supplied) because of the shutdowns. Assume that before the crisis the economy was at the maximum level of employment.

(a) (4 points) Suppose there is perfect downward rigidity in wages. In the aggregate labor market show graphically the effects of the shutdowns as described above, ignoring any demand effects.

(b) (4 points) What happens to wages, employment, unemployment and output in the economy?

(c) (2 points) Would your answer be any different if the labor market did not experience any downward rigidity in wages? Why or why not?

(d) (6 points) Can the government use the tools of fiscal policy to return the economy to the outcome before the pandemic? Why or why not? Briefly explain a fiscal policy tool and also support your argument with a graph.

(e) (4 points) Use the quantity theory of money to assess the likely effects on inflation coming from the shock as described in this question. Also assess the effects on inflation coming from the use of fiscal policy (after the shock).

Question 2:

The following table shows data for four different countries, which includes the average years of schooling of the typical individual in each country and the labor force.

Country Average Years of Schooling Labor Force

Pakistan 5.02 73,943,770

Mexico 8.79 57,142,190

United Kingdom 12.24 34,530,460

South Korea 12.05 28,410,820

For this question let Y represent real GDP (output), K be the capital stock, H represent the efficiency units of labor, h the human capital per worker and L be the labor force.

(a) (3 points) Briefly explain the concept of efficiency units of labor.

(b) (5 points) The table above shows data for four countries, listed by the size of the labor force (from largest to smallest). The average years of schooling can be understood as a measure of human capital per worker. Calculate the efficiency units of labor based on the data and rank countries accordingly.

(c) (2 points) Do you see any interesting changes in ranking based on the data given at the beginning of the question and your calculations in the previous part? Briefly explain.

Consider the general aggregate production function that we discussed in class:

Y = AF(K, H)

Assume that H is constant at H = H and only A and K can vary

(d) (4 points) Sketch the production function briefly explain its shape. That is, explain what assumption or property explains the shape.

(e) (6 points) Suppose you observe that one country (R) produces a lot of output and another country (P) produces very little: Y R YR K K Using the graph above, show two different reasons why countries differ in their production. Explain each example briefly in words