Question

In August 2020, Haiti and the Dominican Republic, two Caribbean economies, were hit by hurricane Laura, experiencing a negative aggregate supply shock as a result.(a)Haitians assume this is a one-time shock, so it is expected to have no wealth effects.Use the labor market and the production function to describe the effects on employment, output, and the real wage. (b) In the Dominican Republic the shock is believed to be permanent, so there is a negative wealth effect. Redo (a). What are the differences?

Answer 1

a))....Haitians assume this is a one-time shock, so it is expected to have no wealth effects.Use the labor market and the production function to describe the effects on employment, output, and the real wage

1).   A production function shows how much output can be produced with a given amount of capital and labor. The production function can shift due to supply shocks, which affect overall productivity.

2.   The upward slope of the production function means that any additional inputs of capital or labor produce more outputThe marginal revenue product of labor equals the marginal product of labor times the price of the good. The nominal wage equals the real wage times the price of the good. Dividing each of these through by the price of the good means that an equivalent profit-maximizing condition is the marginal product of labor equals the real wage.

A temporary increase in the real wage increases the amount of labor supplied because the substitution effect is larger than the income effect. The substitution effect arises because a higher real wage raises the benefit of additional work for a worker.

When labor supply increases, full-employment output increases, as there is now more labor available to produce output.

b))...In the Dominican Republic the shock is believed to be permanent, so there is a negative wealth effect. Redo (a). What are the differences?

The wealth effect is a behavioral economic theory suggesting that people spend more as the value of their assets rise. The idea is that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value. They are made to feel richer, even if their income and fixed costs are the same as before.

KEY TAKEAWAYS

• The wealth effect posits that consumers feel more financially secure and confident about their wealth when their homes or investment portfolios increase in value.
• They are made to feel richer, even if their income and fixed costs are the same as before.