IGNOU BECC 106 Solved Assignment 2022-23

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Submission Date :

31st March 2033 (if enrolled in the July 2033 Session)
30th Sept, 2033 (if enrolled in the January 2033 session).

Answer the following Descriptive Category questions in about 500 words each. Each question carries 20 marks. Word limit does not apply in case of numerical questions in Assignment One.

Answer the following Middle Category questions in about 250 words each. Each question carries 10 marks. Word limit does not apply in case of numerical questions in Assignment Two.

Answer the following Short Category questions in about 100 words each. Each question carries 6 marks in Assignment Three.

Answer all the questions.

Assignment One

1) Derive the AS curve from the WS and PS relations. Discuss the factors that influence the position of the AS curve.

The New Keynesian model uses an efficiency wage model for the labour market (Carlin and Soskice 2015). This allows us to explain unemployment and the failure of wages to clear the labour market. The supply of labour is determined by the wage setting (WS) curve. The higher the wage, the more willing people are to work. The demand for labour is shown by the price setting (PS) curve. Firms offer wages based on the level of productivity, the level of competition, taxes and other factors. You can revisit the CORE textbook for more details on the labour market supply model.

Efficiency Wage model (Carlin and Soskice 2015)

The efficiency wage idea was first proposed by (Shapiro and Stiglitz 1984) in a paper called Equilbrium Unemployment as a Worker Discipline Device.

The model for the supply side of the economy is also based on monopolistic-competition where firms have market power to set prices. There can be changes in the level of competition based on the number of firms in an industry. The greater the market power, the more firms are able to increase their mark-up or profit margins. At the extremes, there are perfectly competitive and monopolistic markets.

It is assumed that wages and prices are not adjusting continuously but are changed infrequently. (Barattieri, Basu, and Gottschalk 2010) analysed wage setting in the US and found that wages were sticky. A simple model would suggest that wages are set once a year. This does not appear to vary much across different industries. (C. Campbell and Kamlani 1997) surveyed 184 firms and found that most firms were reluctant to cut wages in a recession. Firms felt that they would lose their best workers. Firms also thought that it would damage moral and reduce effort. (Bewley 2007) review literature on wage rigidity and fairness and found that wage cuts were only perceived as being fair if they saved a large number of jobs. This may explain why wages do not tend to fall to clear the market during a recession. However, rigidities in price setting varies by industry.

Nominal wages do not adjust immediately to fluctuations in aggregate demand. Economic agents set wages and prices with a target real value that requires some assumption about future inflation. The real wage (w) is the nominal wage (W) deflated by the price level (P).

$w = \frac{W}{P}$

For this New Keynesian model, wages are set once a year during the wage round and prices are adjusted after that. Therefore, wages and prices adjust to aggregate demand with a lag. In this case a positive demand shock will lead to higher employment, lower unemployment and an increase in wages (as a move up the WS curve). Firms respond with an increase in prices. We assume that the mark-up or profit-margin is unchanged. All firms in the industry increase wages.

Changes in equilibrium unemployment.

Equilibrium unemployment will rise if the WS curve shifts upwards or the PS curve moves downwards.

An increase in unemployment benefits would shift the WS curve upwards. There is a trade off between the effect that an increase in benefits has on reducing the cost of job losses and the need to shift to a lower point on that wage setting curve to ensure productive output. This is achieved with a higher level of unemployment.
Higher mark-ups as a result of lower competition. The PS curve is reduced and a higher share goes to profits. There is less employment and lower real wages. This may be something to consider with recent examples. With the higher cost of job loss the real wage is lower.

Policies that shift the WS or PS curves will affect the level of equilibrium unemployment and the growth rate of the economy. These are supply side policies that we will focus on in Chapter .

Labour-supplyAnalysis of the supply-side of the economy is broken down into two parts: supply-side effects on unemployment; nominal rigidities.

$w = P e B (N, z)$

Where the wage $(W)$ is determined by the expected price level, the level of employment $(N)$ and a set of wage-push variables $(Z) .$ This will include changes in benefits and the presence of unions.

Though nominal wages are set or negotiated, works are interested in the real wage. The wage-setting (WS) real-wage equation is

$w (W S) = W / P e = B (N, Z)$

The opportunity cost of taking a job is dependent on two factors: benefits and the disutility of working. The wage is above the opportunity cost of working and increases as the unemployment rate falls. As unemployment falls firms have to pay more to get people to work hard as there are lots of job opportunities. There are a number of enhancements that can be applied, including adding monopoly unions. As such, changes in institutions can affect the WS curve and the equilibrium level of unemployment.

Labour-demand

In a competitive market the firm sets prices and the quantity of labour required with reference to the marginal product of labour. In this case $P = M C a n d W / P = M P L$ . However, once there is market power, as is the case with our assumption of monopolistic competition, firms facing a downward-sloping demand curve will produce to maximise profits. The mark-up on marginal cost will be depend on the elasticity of demand, which will be influenced in a positive direction by the level of competition. As elasticity rises the mark-up will fall. A horizontal PS curve is usually employed, if firms set prices according to a mark-up over costs. Now the fixed output per worker is split between profit per worker and the real wage per worker. The real wage is the marking-up of unit labour costs by a fixed percentage $(μ)$ .

Therefore,

$P = (1 + μ) (W / λ)$

Where $λ$ is output per worker $(y / N)$ .

Output per worker is divided into real wages per worker and real profits per worker.

Productivity, prices and wages

There is a divergence between the real consumption wage (based on post-tax income and excise duties prices) and the real product wage that is paid by the employers – including income tax and other taxes relative to the price that is received for product after indirect taxes are paid. The difference is the tax wedge. The tax wedge is one of the price-push factors that may affect the PS wage.

$W^{P} S = λ F (m u, z)$

Changes in productivity, competitive conditions and taxation can change the price-setting wage. Other price-push factors are business regulations and employment relations, Some health and safety regulations may impose costs but provide an offsetting increase in productivity.

Labour market equilibrium is at the intersection of the upward sloping WS curve and a flat or downward sloping PS curve.

$W^{w} s = W^{p} s$

$B (N, z_{w}) = λ F (μ, z_{p})$

2) In an open economy with floating exchange rate, analyse the effectiveness of fiscal
policy and monetary policy.

Monetary policy involves the management of the money supply and interest rates by central banks. To stimulate a faltering economy, the central bank will cut interest rates, making it less expensive to borrow while increasing the money supply. If the economy is growing too rapidly, the central bank can implement a tight monetary policy by raising interest rates and removing money from circulation.

Fiscal policy, on the other hand, determines the way in which the central government earns money through taxation and how it spends money. To stimulate the economy, a government will cut tax rates while increasing its own spending; while to cool down an overheating economy, it will raise taxes and cut back on spending.

There is much debate as to whether monetary policy or fiscal policy is the better economic tool, and each policy has pros and cons to consider.

Central banks use monetary policy tools to keep economic growth in check and stimulate economies out of periods of recession.
While central banks can be effective, there could be negative long-term consequences that stem from short-term fixes enacted in the present.
Fiscal policy refers to the tools used by governments to change levels of taxation and spending to influence the economy.
Fiscal policy can be swayed by politics and placating voters, which can lead to poor decisions that are not informed by data or economic theory.
If monetary policy is not coordinated with a fiscal policy enacted by governments, it can undermine efforts as well.

An Overview of Monetary Policy

Monetary policy refers to the actions taken by a country’s central bank to achieve its macroeconomic policy objectives. Some central banks are tasked with targeting a particular level of inflation. In the United States, the Federal Reserve Bank (the Fed) has been established with a mandate to achieve maximum employment and price stability.

When a country’s economy is growing at such a fast pace that inflation increases to worrisome levels, the central bank will enact restrictive monetary policy to tighten the money supply, effectively reducing the amount of money in circulation and lowering the rate at which new money enters the system. Raising the prevailing risk-free interest rate will make money more expensive and increase borrowing costs, reducing the demand for cash and loans.

The Fed can also increase the level of reserves commercial and retail banks must keep on hand, limiting their ability to generate new loans. Selling government bonds from its balance sheet to the public in the open market also reduces the money in circulation. Economists of the Monetarist school adhere to the virtues of monetary policy.

When a nation’s economy slides into a recession, these same policy tools can be operated in reverse, constituting a loose or expansionary monetary policy. In this case, interest rates are lowered, reserve limits loosened, and bonds are purchased in exchange for newly created money. If these traditional measures fall short, central banks can undertake unconventional monetary policies such as quantitative easing (QE).

Assignment Two

3) How do you reconcile the vertical long run Phillips curve with the downward sloping
short run Phillps curve? Explain through a diagram.

4) Specify the equation of the IS curve for an open economy. What are the factors that
cause a shift in the IS curve?

5) Bring out the salient features of the monetary approach to exchange rate determination.

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Assignment Three

6) Explain the concept of natural rate of unemployment. For an economy, can natural rate unemployment be zero?
7) Explain why “balance of payments always balances”.
8) Explain the concept of rational expectations.
9) What are the effects of an expansionary fiscal policy on output and prices?
10) Write down the equation of adaptive expectations hypothesis. Illustrate it with an
example.

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