Macroeconomics and Economic Policy

Gregory de Walque

Chapter 13: exercises

13.1 .
(a) False. The theory points no particular relationship between technological progress and employment, especially in the long run
(which is the dimension considered in the question as is clear from
the expression "steady increase in employment"). In the short run,
an increase in technological progress can have either a positive or
a negative eect on employment, depending of the direction of
the shift in the aggregate demand (aggregate supply always shifts
right). If AD shifts right also (case of a technological progress
that makes existing capital stock obsolescent and gives the rms
an incentive to invest in new capital goods that embeds the new
technology), employment will clearly be pushed upwards in the
short run. If AD shifts to the left su ciently strongly (case of a
technological progress that does not take the form of an investment in a new technology, but rather of a more e cient use of the
existing technology), the short run eect on employment can be
even negative, as there is no further investment and the more e cient use of the new technology allows to get rid of some workers.
In the medium run, the natural unemployment rate can only be
aected by technological progress if the latter is badly forecasted
by the workers when setting the W S curve. If Ae 6= A, the P S
shifts up by + A while the W S curve shifts up only by + Ae <
+
A such that the intersection of the two curves result in a lower
natural rate of unemployment.
(b) False. Creative destruction tends to benet more to more educated
workers (with higher skills).
(c) True. The process of technological progress produces a stronger
demand for skilled workers while less and less unskilled workers
are needed for the basic tasks.
(d) True. The sentence "The increase in output is smaller than the
increase in productivity" can be translated in mathematics as follows
gY

< g Y gN
, gN < 0
1

which indeed corresponds to a decrease in employment.

(e) True. If aggregate demand growth (gY ) lays behind productivity
growth (gY gN ) we re exactly in the case described above in (d).
(f) True. If technological progress remains unexpectedly high during
a period, for this period the P S curve shift up more than the W S
curve does, yielding a decrease in the natural rate of unemployment as already explained in the point (a) above.
(g) It depends whether technological progress is correctly anticipated
or not. If it is correctly anticipated, having technological progress
or not will not aect the natural unemployment rate since both
the W S and P S curve will shift by the same amount, such that
their intersection will always occur for an identical un (even though
corresponding to a higher real wage W=P ). If it is not correctly
anticipated, then stopping technological progress will aect negatively the natural rate of unemployment as already explained
above in (a) and (f).
13.2 This statement is false. Higher labour productivity, i.e. higher technological progress can at best reduce the natural rate of unemployment
for some time, as long as technological progress is not fully anticipated
by the workers and reected in increases in the real wage (see points
13.1(a), (f) and (g) above). It will thus not shift unemployment down
permanently. On the other side, it is true that technological progress
puts a downward pressure on prices, since less labour production factor
is required to produce the goods.
13.3 Lets consider the following P S and W S curves
W
A
W
,
=
A
P
1+
W
W = Ae P e (1 u) , e = Ae (1
P
P = (1 + )

u)

(a) If P e = P but Ae 6= A, then a shift in A will not shift the P S

and W S curves by the same amount. If Ae < A, the natural
unemployment rate will decrease, as the P S curve increases more
than the W S curve. If Ae > A, the natural unemployment rate
will increase, as the P S curve increases less than the W S curve.

(b) If P e = P but Ae = A then the P S and W S curves crosses when

W
P

A
1+

, u=1

= A(1
1
1+

u)
=

1+

0:08
= 0:074 = 7:4%
1 + 0:08

...
(c) ...and we see that the natural rate does not depend on productivity
since A cancels out in the rst line of the computation above. As
seen in point (a) above, the natural rate of unemployment will only
be aected if Ae 6= A, i.e. for unexpected changes in productivity.
13.4 .
(a) One can hope that increasing spending on computers at public
school should benet to those for who that will only attend public
school and no else further education. They will be relatively more
skilled than in the absence of this spending. Therefore it should
benet to low skilled workers, but only in the medium to long run,
when these pupils will enter the labour force.
(b) limiting the number of foreign temporary farm workers will provoke an articial scarcity in low skilled workers. This should also
benet to the wage of this segment of the labour force.
(c) An increase in the number of public colleges should help reduce
the private cost of education. Students who otherwise would have
stopped their cursus sooner will continue to study somewhat more,
increasing the number of skilled workers versus the number of low
skilled worker. This could decrease the scarcity in skilled workers,
decreasing their wage and increase the relative scarcity in unskilled
workers, increasing their relative wage.
(d) Central America countries workers are, on average, less skilled
than US workers and they work for a lower wage than unskilled
US workers. If Central America countries oer tax credits to US
rms, those rms will benet from an articial (scal) advantage
to install there for they activities necessitating low skilled workers.
Doing this, their demand for unskilled workers in US will decrease,
pushing downwards the unskilled workers wages.
13.5 It is true that technological progress in the agricultural sector has allowed to dramatically increase the production of agriculture while employment in this sector decreased even more dramatically. However, at
3

the aggregate level, one cannot say that employment has been destroyed
in the United States. The overall number of workers is much bigger now
than it was at the start of the last century. This means that the workers
who are not needed anymore in the primary sector have found a place
to work in another sector that started to grow at the same time that
less farmers were needed: industry. Later on the productivity gain in
industry (and competition from emerging countries) have pushed the
labour force towards the service sector. Note that the service sector is
now becoming much more heterogenous than it was previously, with
some services requiring relatively few skills (e.g. haircut) while others require on the contrary very high skill (e.g. consultancy services
for rms regarding IT implementation, tax optimization, marketing,
production organization, ...).
We thus conclude that technological progress may indeed kill jobs
within a particular sector, but in the medium and long run this will
be compensated by a stronger labour demand in other segments of
the economy. However, higher technological progress go along with a
stronger demand for skill labour.
13.6 Lets consider the following equations describing production function,
P S and W S curve together with the relationship between employment
and unemployment rate:
Y
W
P
W
Pe
N

= AN
A
=
1+

(P S curve)

= Ae (1
= (1

u) (W S curve)
u)L

(a) Referring to chapter 7, we obtain the aggregate supply curve by

equating the W S and the P S curve in order to get a relationship
between the aggregate price level on the one hand (P ) and GDP
(Y ) and expected price level (P e ) on the other hand:
P

A
1+

= P e Ae (1

u)

Ae
(1 u)
A
Ae Y
, P = P e (1 + )
(AS curve)
A AL
, P = P e (1 + )

where the last step is obtained from the production function and
the relationship between employment and unemployment rate
N

Y
= (1
A

, (1

u) =

u)L
Y
.
AL

Therefore, in the (Y; P ) plane, the AS curve is

- positively sloped (if Y increases, P increases as well);
- its position depends positively on the price mark-up , the
price expectation P e and of the expected level of technological
progress, i.e. if , P e or Ae increases, the AS curve shifts up;
- its position depends negatively on the price actual level of
technology A and on the labour force L.
e

(b) If A and Ae shift by the same amount, then AA = 1 and the AS

curve shifts down because of the increase in labour productivity
induced by the increase in A:
Y
(AS curve)
A"L
This shifts the AS curve down and to the right, such that for
the same price level corresponds a higher GDP reecting that for
the same labour cost per worker (wage), the economy is able to
produce more. Note that in this case, the potential output (determined by the natural rate of unemployment) is left unchanged.
P = P e (1 + )

(c) Assume now that A shifts up but that Ae doesnt. Then we have
P = P e (1 + )

Ae Y
(AS curve)
A "A " L

and the AS curve is shifted down and right but much more than in
(b) above since A appears now twice in the denominator. Furthermore, if A shifts up but not Ae , the natural unemployment rate
will decrease. Therefore the potential output increases, yielding to
a permanent increase in real output.
13.7 We assume a dual labour market with high-skill and low-skill labour.
(a) If the labour force is unchanged and that the demand for the
high-skill segment increases while the demand for the low-skill
segment decreases, the real wage of high-skilled workers will tend
to increase and this of low-skilled workers will tend to decrease.
5

(b) In a country with minimum wage legislation, the wage cannot

decrease to lower levels than xed by law. If ever the wages for
low-skilled workers was pushed down to the minimum wage limit,
any further downward pressure would then translate into more
unemployment in this segment of the labour market. Therefore
we may conclude that limiting the wage exibility usually end up
into more unemployment.
(c) After an increase of demand in the high-skill segment and a decrease of demand in the low-skill segment, the wage inequality
will be higher in the country without minimum wage legislation.
In the country with minimum wage legislation, from the moment
the limit of the minimum wage is hit, the wage distribution will
be relatively less unequal, but the unemployment will increase,
creating another form of inequality.
(d) The labour market is indeed less exible in European countries
than in the US, not only because of minimum wage legislation,
but also because of the higher degree of unionization of the economy and some other practices like wage indexation to price level,
longer duration of wage contract or a higher protection of labour
(higher ring costs for example). This lack of exibility in the
labour market has indeed led the last two decades to less inequality in labour revenues in European countries, but the other side
of the coin is the structurally higher rate of unemployment. Furthermore, changes in unemployment are much more persistent in
Europe than in the US, an observation that has led to the name
hysteresis.
13.8 We consider the W S curve
W
P

= F (u; z )
+

with u = 1

N
L

(a) The W S curve can then be rewritten as

0
1
B
N C
W
=FB
1
; zC
@
A
P
L
| {z } +

and the real wage demanded by the workers increases as employment becomes higher. The W S curve may thus be re-interpreted
6

as the supply of labour by the workers, where workers agree to

work more (N increases) against higher real wages).
(b) If the P S curve is given by
P = (1 + ) M C
W
with M C =
MP L
(ATTENTION there is a fault in the statement of the exercise!!!,
M C = MWP L and not M C = W M P L!!!)
(c) ...and substituting for M C into the price setting equation we obtain
P

W
MP L
MP L
W
=
,
P
(1 + )
= (1 + )

(d) Note that the M P L (marginal productivity of labour) depends on

the form of the production function. In chapter 6, with
Y =N
the M P L was computed as
@Y
=1
@N
which is constant and independent of labour. For a more general
production function of the type used in chapters 11 and 12 as
= K N1
@Y
MP L
= (1
@N
Y

K
N

which depends negatively on labour (i.e. the higher employment

is, the lower the marginal productivity of labour). Since
@(W=P )
1
=
>0
@M P L
(1 + )
@M P L
K
and
= ( )(1
) 1+ < 0
@N
N
@(W=P )
@(W=P ) @M P L
=
<0
then
@N
@M P L
@N
7

and we see that the P S curve can be also interpreted as the labour
demand curve by the rms, which is downward sloping. For a
given real wage, rms will hire workers up to the point where
hiring one more worker will make drop the marginal productivity
of labour below the marginal cost (equal to the wage). For prot
maximizing rms, this is equivalent to the price setting equation.