Answer to Question #275201 in Macroeconomics for michael

Question

Suppose there is a permanent increase in total factor productivity (i.e., both current productivity and future productivity rise). Determine the equilibrium effects of this on current aggregate output, current employment, current real wage and interest rate, current consumption, and current investment. Show how the impact differs from the case where total factor productivity increases only in the current period. Explain your results.

Answer 1

Total factor productivity measures the residual growth in total output of a firm or industry, that cannot be explained by the accumulation of traditional inputs such as labor and capital.

A permanent increase in total factor productivity will result in:

• An increase in current aggregate output because the production level will go up,
• An increase in current employment because an increase in production will mean more job opportunities,
• An increase in current real wage following high level of productivity,
• A decrease in real interest rate because there will be more money in the hands of the consumers. Consumers will want to make more purchases and increase borrowing.
• An increase in current consumption due to increase in real wage,
• An increase in investment because there will be more savings.