Question 5
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According to Neoclassical theory of distribution, the real wage earned by any worker equal that
worker marginal productivity. Let us this insight to examine the income of two group workers:
farmers and barbers
a) Over the past century, the productivity of farmers has risen substantially because of
technological progress. according to the neoclassical theory, what would have happend to their
real wage?
b) In what units the real wage measured
c) Over the same period, the productivity of barbers has remained constant. What should have
happend to real wage?
d) In what units wage inpart c is measured
e) suppose workers can move freely between being farmers and being barbers. What does this
mobility implies for wages of farmers and barbers.
f) What do your previous answer imply for the price of haircuts relative to the price of food?
g) Who benefits from technological progress- barber or farmer?
Solution
a. According to the neoclassical theory, technical progress that increases the marginal product of
farmers causes their real wage to rise.
b. The real wage in (a) is measured in terms of farm goods. That is, if the nominal wage is in dollars,
then the real wage is W/PF, where PF is the dollar price of farm goods.
c. If the marginal productivity of barbers is unchanged, then their real wage is unchanged.
d. The real wage in (c) is measured in terms of haircuts. That is, if the nominal wage is in dollars, then
the real wage is W/PH, where PH is the dollar price of a hair- cut.
e. If workers can move freely between being farmers and being barbers, then they must be paid the
same wage W in each sector.
f. If the nominal wage W is the same in both sectors, but the real wage in terms of farm goods is
greater than the real wage in terms of haircuts, then the price of haircuts must have risen relative to
the price of farm goods.
g. Both groups benefit from technological progress in farming
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Suppose that an increase in cosumer confidence raises consumer expectations about the future
income and thus increases the amount they want to consume today. this might be interpreted as
upwards shift in the consumption function.
how does this shift affect investment and interest rate.
If consumers increase the amount that they consume today, then private saving and, therefore,
national saving will fall. We know this from the definition of national saving:
National Saving = [Private Saving] + [Public Saving]
= [Y – T – C(Y – T)] + [T – G].
An increase in consumption decreases private saving, so national saving falls
saving and investment as a function of the real interest rate. If national saving decreases,
the supply curve for loanable funds shifts to the left, thereby raising the real interest rate
and reducing investment.
If consumers increase the amount that they consume today, then private saving and, therefore,
national saving will fall. We know this from the definition of national saving:
National Saving = [Private Saving] + [Public Saving]
= [Y – T – C(Y – T)] + [T – G].
An increase in consumption decreases private saving, so national saving falls
saving and investment as a function of the real interest rate. If national saving decreases,
the supply curve for loanable funds shifts to the left, thereby raising the real interest rate
and reducing investment.
if investment increases for any given interest rate, this causes the equilibrium in the goods market to
shift to the right (If you've learned the Keynesian cross, this is the Y=C+I+G+NX curve shifting
upwards, which can be shown as a shift in the IS curve to the right.) This means that people demand
more goods at any given interest level. LM curve is unaffected.
In terms of aggregate demand/supply, this can be shown as a shift to the right in aggregate demand.
The result is an equilibrium where output is higher and price is higher (provided an upward sloping
aggregate supply curve).