Question

Suppose the economy is in a recession and the unemployment rate is exceptionally high. use graphical tools along with a "story"

4. Explain why Keynes felt “deficit spending” was an appropriate action for government if the goal is to get out of the recession, even though it may hurt the standard of living of the average worker.

5. Show that a technological breakthrough that greatly increases labor productivity could help reduce the unemployment rate without hurting the standard of living of the average worker. (You only need to use the labor market here.)

Answer 1

3.

In the above diagram, economy is in recession where price level is P' and output is Q' that is less than the potential level of output and less than the price level at LR equilibrium. In this scenario, a lower inflation rate implies that a higher unemployment rate in the economy as per the short run Phillips curve as well.

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4.

Keynes felt it because, deficit spending is going to create demand that is further going to stimulate overall AD. It will make Ad curve to shift to the right. When AD increases, then SRAS also increases to cater the demand. While doing so, it makes new jobs and people start spending money. So, by this way, economy comes out of the recession even if employees get the jobs at the lower wage level or experience workers settle for the lower wage rates. So, their average standard of living may decrease, but economy gets better and come out of the recession.

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5.

When technological advancements takes place and productivity increases, then cost of production decreases. It makes firms to hire more workers and demand for the workers increase. Workers can also get higher wages in the market. It i shown in the following labor market diagram.