Question

1. Suppose that the economy is hit by the coronavirus crisis. One way to represent this in the model is as lower productivity z, since some businesses need to reduce operations, and workers are less productive.

a) Using the two-sided search model, determine the effects of lower z on the unemployment rate, the vacancy rate, the labour force, aggregate output, labour market tightness, and the wage. Use diagrams, and explain your results.

b) Assume that to restore employment after the crisis, the government implements policies that make it cheaper for firms to hire workers. Analyze their effect on the unemployment rate, the vacancy rate, the labour force, aggregate output, labour market tightness, and the wage. Use diagrams, and explain your results. In your analysis, only consider a change in the cost of hiring. Ignore changes in z in your answer.

(Note to expert: Please answer both a and b as they are both part of the same question)

Answer 1

1. Reduction in operation and less productivity of workers together lead to reduction in demand for labor in the economy. Therefore, vacancy declines and unemployment increases.

Low productivity leads to reduction in wages that is shown in panel 1. As vacancy declines, vacancy supply curve shifts to the left.

Increase in unemployment rate reduces aggregate supply and aggregate output of the economy. Due to economic crisis, several productions are stopped for time being.

Hence, job cut is the only way to cost cut too save firm from huge loss. Bargaining power of workers also decline due to loss in productivity.

2. When government announces some measures to make workers cheaper to hire, it induces firms to demand more labor to run the production.

Hiring more labor is no more costly to the firm thus recruitment will help to increase production without creating much pressure on profit. Hence, vacancy again increases.

Vacancy supply curve again returns to the initial position. Increase in labor supply raises aggregate supply or output. Due to labor market rigidity, wage adjustment is slow.