## Related questions with answers

A temporary TFP shock: Suppose the economy is hit with a temporary positive TFP shock. For example,
suppose weather conditions are temporarily very favorable for agriculture.

(a) Analyze the effect of the shock in the labor market diagram of a standard DSGE model (with no sticky prices or
wages). What is the effect on the real wage and employment in the short run?

(b) How would your answer change if there are sticky prices? Discuss how your answer relates to the impulse
response functions shown in previous Figure.

Solution

VerifiedThe content below represents what would happen if there are positive shocks to TFP in the agriculture industry.

**A)** If we take a look at our labor demand equation ( $\omega =\frac{2}{3}\times \frac{\overline{A}K^\frac{1}{3}}{L^\frac{2}{3}}$) we can see that a positive TFP shock will increase our parameter $\overline{A}$ thus shifting the demand curve to the right.

There is no shift in our labor supply curve ( $L^s=\overline{\ell}\times \frac{\omega}{c}$ ), we can observe that there is an increase in employment and wages because firms motivate their workers to work more due to the positive TFP shock.

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