Question

a) Show the impact of this shock (DEREGULATION) on the production function, equilibrium labor and wage, and full-employment level of output (i.e. Y ). Draw diagrams, label the figures, and clearly illustrate the impact on each variable. LABEL THE AXES & the CURVES!

b) NOW DISCUSS how the shock effected the economy, including the wages and employment, as well as full-potential. You should discuss the impact on the production function (if any), the labor market ( N and w) and the full-employment level of output.

Answer 1

A) Image Uploaded

B) Deregulation refers to the removal of certain restrictions that were placed by the government which were a hindrance to the operation of economy at its full potential. Due to the removal of these hindrances, the economy can function more efficiently, with new resources available to explore and new methods of production that it can import. This results in the increase of productivity of factors of production and the overall efficiency of the economy.

Let's assume the production funtion to be Y= A f(K,L)

A refers to the efficiency of economy

K refers to the Capital

L refers to the Labor

Since after the deregulation the efficiency increases, new production function will be Y'=A' f(K,L)

where A'>A and hence Y'>Y. Therefore the production funtion will move up.

Similarly in the labor market, due to deregulation, the new technologies are explored which results in the increase of Marginal Product of Labor. This shifts the labor demand curve to the right. Assuming demand of labor to be decreasing in wage and supply of labor to be increasing in wage, the rightward shift of demand of labor curve results in increase in the level of employment and rise in the wage level.

Also, the technology shock results at higher level of output and hence the natural level of output in the long run moves up.