Answer to Question #110425 in Macroeconomics for Sweta

Question

1) How does the 'efficiency wage' prevent the economy from achieving full-employment?

2) With the help of Lucas' model, show how supply and demand shocks are mitigated in the presence of rational expectations and Lucas' supply curve.

Answer 1

1).Efficiency wage prevents the economy from achieving full employment in that workers are paid more than the equilibrium wage.There maybe unemployment as the above market wage rates will attract more workers.

2).The cornerstone of Lucas new classical theory is the concept of rational expectations. By ratio­nal expectations Lucas means that people use all available relevant information to make economic forecasts about price level. This information includes not only explicit changes in money supply, Government’s fiscal policy, international developments which determine exports and prices of fuel, raw materials, and other commodities but also economic theory about how the economy works.Lucas is of the view that it is only unanticipated changes in aggre­gate demand that are the cause of cyclical fluctuations in the economy.