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level: Level 1

Questions and Answers List

level questions: Level 1

Question	Answer
General premise: workers’ productivity depends positively on their wage.	Efficiency wage theory (New Keys. Overhead1)
1. Shirking model (Shapiro and Stiglitz (1984)) 2. Gift-exchange/Fair wage theory (Akerlof (1982, 1984), Akerlof and Yellen (1990)) 3. Labor turnover (Salop (1979), Schlicht (1978), and Stiglitz (1974)) 4. Firm-specific human capital 5. Adverse selection (Weiss (1980)) adverse selection based on hires adverse selection based on quits	Efficiency wage theory versions (New Keys. Overhead1)
Intuition: the elasticity of efficiency w.r.t. the wage should equal 1. A firm can raise output either by hiring more workers or by paying a higher wage. At the margin, both strategies should have the same effect on output. Implications of model 1. Equilibrium may be characterized by involuntary unemploy¬ment, since each firm may have an incentive to pay a wage above its market-clearing level 2. The unemployment rate depends only on parameters from effort function. The production function is irrelevant to determining the equilibrium unemployment rate 3. The firm may have the incentive to keep wages fixed, even when the unemployment rate rises.	General efficiency wage model (New Keys. Overhead1)
Additional findings: a. the estimated differences are not greatly changed when the sample is restricted to workers not covered by union contracts b. the estimated differences are quite stable across time and across countries c. there is no evidence that working conditions are worse in high-wage industries, so that the differences do not appear to represent compensating differentials d. workers in industries with higher estimated wage premia quit much less often. Thus, the differences appear to represent genuine rents e. workers who change to a job in a different industry on average experience wage changes approximately equal to the difference in the estimated wage premia for the two industries f. when workers lose their jobs because of plant closings, the wage cuts that workers experience when they find new jobs are much higher when the jobs they lost were in high wage industries	Dickens and Katz (1987) and Krueger and Summers (1988) (Gen EFficiency Model Nk#1)
Workers tend to be risk-averse and firms are risk-neutral (or at least less risk-averse). Firms and workers reach a common understanding to keep wages stable. Problems w/ implicit contract theory: 1. predicts that real wage is countercyclical 2. firm has the incentive to always claim it is the good state	implicit contract theory (nk#1)
Firms have better knowledge of the state of the world (Ai). Thus they are responsible for observing and announcing the state of the world Contract must have the characteristic that firm has incentive to be truthful Contract specifies high employment and high real wage in good state and low employment and low real wage in bad state However, difference in compensation between two states is the lowest level possible that still gives firms an incentive to be honest	Implicit contacts with asymmetric information (nk#1)
2 groups: insiders and outsiders Insiders possess bargaining power with firm. Why don't firms fire insiders and hire unemployed outsiders at a lower wage?	Insider-Outsider theory (nk#1)
Gain to cutting price – more output sold. Cost of cutting prices – lower profit per unit. At the profit-maximizing price, the gain and the loss exactly offset each other. At a price slightly above the profit-maximizing price, the gain is only a little smaller than the loss. Note that it is privately optimal for the firm to cut prices if B–A > cost of changing prices. However, it is socially optimal for the firm to cut prices if B+Y>cost of changing prices.	Models with menu costs or near rational behavior (nk#2)
Assumptions 1. There is a continuum of differentiated goods, indexed by 2. each good is produced by a single firm with monopoly rights over the good’s production 3. Production function: 4. Utility function for households: 5. C is an index of a household’s consumption of various goods, 6. All output is consumed, so Y=C 7. Aggregate Demand: y=m/p	New Keynesian contract models (nk#2)
Shows that price stickiness at the firm level does not mean that aggregate prices are sticky	Caplin-Spulber model (nk#2)
Klenow and Kryvtsov (2008) Prices are collected by 400 employees, who visit 20,000 retail outlets a month, mainly in 45 large urban areas Findings: price changes are freuquent, price cahnges are large in abs alue, many price changes are small, price durations are variable, hazard rate are flat, size of price change is unrelated to time, intensive margin dominate the variance of inflation (intensive margin: average size of price change)	Evidence on Price Stickiness (nk#2)
x	Phillips curve (nk#2 & PC)
_	Search and Matching Models
Search and matching models cannot generate the observed business cycle frequency fluctuations in unemployment and vacancies in response to shocks of plausible magnitude Simulations with both productivity and separation shocks Simulations with shocks to bargaining power – imply that wage setting may be key to explaining fluctuations	Search and Matching2 - Shimer (2005)
Wage rigidity does not explain Shimer’s results Patterns observed in U.S. data may be explained by higher value of non-work and fixed cost of a vacancy Wage changes for workers who change jobs For job changers, wages are at least as cyclical as labor productivity, so wage rigidity is not the solution	Search and Matching2 - Pissarides (2009)
Continuum of households indexed by tau Households differ in that they supply a differentiated type of labor, so each household has monopoly power over the supply of labor. Households rent capital services to firms and decide how much capital to accumulate, given adjustment costs.	DGSE - Model of Smets and Wouters (2003, 2007)
Way to reduce inflation: initially increase money supply and then reduce its growth rate	Monetary Policy - how to reduce inflation
Benefits of inflation May allow more real wage cuts in equilibrium → lower natural rate May allow economy to recover more quickly from recessions Less likely that zero lower bound on nominal interest rates will be binding	Monetary Policy - inflation benefits
Costs of inflation Cost of converting interest-bearing assets into money Menu costs of changing prices Prices are not at optimal level most of the time (e.g. Caplin-Spulber model) Distorts tax system Inflation makes price comparisons more difficult More difficult for potential customers to decide whether to enter long-term relationship (Okun (1975)) More difficult for parties in a long-term relationship to evaluate fairness of prices	Monetary Policy - inflation cons