Problem
I. You are the Minister of Finance and your Prime Minister has asked you how to make people better off materially. So you ask your Chief Economist to come up with an answer to this request. The Chief Economist knows that the aggregate labour supply can be described using the function Ls = 16 × (W/P) where Lsis the aggregate quantity of labour supplied and (W/P) is the real wage. He also knows that the long-run output of the economy can be described by the production function Y = 60 × K0.5L0.5where Y is the aggregate level of output, L is the aggregate level of employment and and K is the aggregate capital stock in the economy. He also knows from his university courses that the aggregate production function determines the marginal product of labour which in this case equals 1,MPL = 30K0.5/L0.5 .
i. The economists reporting to the Chief Economist have calculated that the total capital stock in the economy is 25. He now has to determine the equilibrium real wage and level of employment for this economy. He's asked you to check his calculations. What would you come up with? The Chief Economists has also asked you to prepare diagrams to show the state of the labour market and the long-run aggregate productive capability of the economy, so he can use them when reporting back to the Minister of Finance.
ii. The Minister of Finance realises she needs an option to take back to the Prime Minister. She knows from talking with business executives that extra funding for their research and development will boost their technology. As Chief Economist you know this would result in long-run output of the economy of Y = 80K0.5L0.5and a marginal product of labour of, MP L = 40K0.5/L0.5 . He has to determine the equilibrium real wage and level of employment again. As before, he's asked you to check his calculations. What would you come up with and how would your diagrams change. The Chief Economist has also asked you to provide a brief explanation for the changes. What would your explanation be?
iii. An annoying opposition politician publicly announces that an increase in the nominal wage (W) will increase the long-run real wage and the level of employment. If you are the Chief Economist what advice would you give the Minister of Finance about replying to this announcement? And what would you tell him would increase the long-run real wage and the level of employment?
iv. The Chief Economist is thinking about long-term sustainable output of the economy as he needs to pass this information on to the Governor of the country's central bank. What would you tell the Governor? And what would it look like diagramatically as a long-run aggregate supply curve for the powerpoint presentation you have to prepare for your Minister?
II. Say you are the annoying opposition figure and you win the next election. You become the Minister responsible for the Department of labour and manage to get your dearest wish of a higher minimum real wage implemented.
i. Since you are a Minister for the same country used in question I) we'll assume the labour market has the same characteristics as it did for a). If the minimum real wage you got passed was 9, would you be happy with your achievement of getting this policy passed?
ii. What about if the minimum real wage you managed to get through parliament was 15? Would you be happy with this