Worth: Mankiw Economics 5e CHAPTER 13 Aggregate Supply 351 moves the real wage away from the target real wage, and this change in the real wage influences the amounts of labor hired and output produced. The aggre gate supply curve can be written as Y=Y Output deviates from its natural level when the price level deviates from the ex pected price level CASE STUDY The Cyclical Behavior of the Real Wage In any model with an unchanging labor demand curve, such as the model we just discussed, employment rises when the real wage falls. In the sticky-wage del, an unexpected rise in the price level lowers the real wage and thereby raises the quantity of labor hired and the amount of output produced. Thus, the eal wage should be countercyclical: it should fluctuate in the opposite direction from employment and output. Keynes himself wrote in The General Theory that an increase in employment can only occur to the accompaniment of a decline in the rate of real wages. The earliest attacks on The General Theory came from economists challenging Keynes's prediction. Figure 13-2 is a scatterplot of the percentage change in real compensation per hour and the percentage change in real GDP using annual data for the U.S. economy from 1960 to 2000. If Keynes's prediction were cor- rect, the dots in this figure would show a downward-sloping pattern, indicating a negative relationship. Yet the figure shows only a weak correlation between the real wage and output, and it is the opphdy procyclical: the real wage tends to rise osite of what Keynes predicted. That is, if he real wage is cyclical at all when output rises Abnormally high labor costs cannot explain the low employ ment and output observed in recessions How should we interpret this evidence? Most economists conclude that the in which the labor demand curve shifts over the bis apply. They advocate models sticky-wage model cannot fully explain aggregate Usiness cycle. These shifts may arise because firms have sticky prices and cannot sell all they want at those prices; we discuss this possibility later. Alternatively, the labor demand curve may shift because of shocks to technology, which alter labor productivity. The theor we discuss in Chapter 19, called the theory of real business cycles, gives a promi- nent role to technology shocks as a source of economic fluctuations For the sticky-wage model, see Jo Anna Gray, Wage Indexation: A Macroeconomic Ap- proach, "Journal of Monetary Economics 2(April 1976): 221-235; and Stanley Fischer, ""Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule, "Joumal of Political Econ y85( February1977:191-205 For some of the recent work on the cyclical behavior of the real wage, see Scott Sumner and Stephen Silver, "Real Wages, Employment, and the Phillips Curve, " Journal of Political Economy 97 (une 1989): 706-720; and Gary Solon, Robert Barsky, and Jonathan A. Parker, "Measuring the Cyclicality of Real Wages: How Important Is Composition Bias? "Quarterly Journal of Economics 109 User JoENA: Job EFFo1429: 6264_ch13: Pg 351: 27758#/eps at 100sm Mon,Feb18,200212:56User JOEWA:Job EFF01429:6264_ch13:Pg 351:27758#/eps at 100% *27758* Mon, Feb 18, 2002 12:56 AM moves the real wage away from the target real wage, and this change in the real wage influences the amounts of labor hired and output produced.The aggre￾gate supply curve can be written as Y =Y − + a(P − Pe ). Output deviates from its natural level when the price level deviates from the ex￾pected price level.1 CHAPTER 13 Aggregate Supply | 351 1 For more on the sticky-wage model, see Jo Anna Gray,“Wage Indexation:A Macroeconomic Ap￾proach,’’ Journal of Monetary Economics 2 (April 1976): 221–235; and Stanley Fischer, “Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule,’’ Journal of Political Econ￾omy 85 (February 1977): 191–205. 2 For some of the recent work on the cyclical behavior of the real wage, see Scott Sumner and Stephen Silver, “Real Wages, Employment, and the Phillips Curve,’’ Journal of Political Economy 97 ( June 1989): 706–720; and Gary Solon, Robert Barsky, and Jonathan A. Parker, “Measuring the Cyclicality of Real Wages: How Important Is Composition Bias?’’Quarterly Journal of Economics 109 (February 1994): 1–25. CASE STUDY The Cyclical Behavior of the Real Wage In any model with an unchanging labor demand curve, such as the model we just discussed, employment rises when the real wage falls. In the sticky-wage model, an unexpected rise in the price level lowers the real wage and thereby raises the quantity of labor hired and the amount of output produced.Thus, the real wage should be countercyclical: it should fluctuate in the opposite direction from employment and output. Keynes himself wrote in The General Theory that “an increase in employment can only occur to the accompaniment of a decline in the rate of real wages.’’ The earliest attacks on The General Theory came from economists challenging Keynes’s prediction. Figure 13-2 is a scatterplot of the percentage change in real compensation per hour and the percentage change in real GDP using annual data for the U.S. economy from 1960 to 2000. If Keynes’s prediction were cor￾rect, the dots in this figure would show a downward-sloping pattern, indicating a negative relationship.Yet the figure shows only a weak correlation between the real wage and output, and it is the opposite of what Keynes predicted.That is, if the real wage is cyclical at all, it is slightly procyclical: the real wage tends to rise when output rises.Abnormally high labor costs cannot explain the low employ￾ment and output observed in recessions. How should we interpret this evidence? Most economists conclude that the sticky-wage model cannot fully explain aggregate supply.They advocate models in which the labor demand curve shifts over the business cycle.These shifts may arise because firms have sticky prices and cannot sell all they want at those prices; we discuss this possibility later.Alternatively, the labor demand curve may shift because of shocks to technology, which alter labor productivity.The theory we discuss in Chapter 19, called the theory of real business cycles, gives a promi￾nent role to technology shocks as a source of economic fluctuations.2