MAC07 Microfoundations

Why the theory of Effective Demand is confusing, and how we can make sense of it.

The Lecture explains that Keynes provides a general broad outline -- a model IDEA, and not a model. Within this outline, there are many ways to fill in the details -- these are the so-called Microfoundations for Keynes. Depending on HOW we fill in the details, we can get to different types of models with different types of phenomena, which may be called effective demand. This means that microfoundations, left unspecified by Keynes, matter in both the interpretation of his theory of effective demand, and also in terms of whether or not the central phenomena: an equilibrium at which unemployment exists - can be demonstrated within the model.

Final Exam Questions:

1 - Explain why, making all assumptions of perfect competition, a laborer will get the marginal product of labor under perfect competition with a Cobb-Douglass production function. However, if the production function is Leontief type fixed proportions, then this does not hold.

2 - What does the empirical evidence support? Cobb-Douglass with labor getting marginal product, or Leontief with labor NOT getting the marginal product.

3 - If the wage does not equal the marginal product, then how is the wage determined? Distinguish between nominal wages and real wages in your answer.