1.Extended unemployment benefits and post-Covid 19 recovery. To address the

economic fallout from the Covid-19 crisis, lawmakers in DC pass a bill to significantly raise unem-

ployment benefits. Some observers, however, are concerned that benefits are now higher than what

many workers make in wage employment. Moreover, they worry that once the crisis passes, it will

be politically di_cult to lower unemployment bene_ts back to pre-crisis levels. We are going to

analyze the economic arguments for and against such extended unemployment benefiits.

a. (6 pts.) Let us start by considering the closed economy, flexible price model of Chapter 3. The

FRED has provided us with the following information about the US economy: The production

function is Cobb-Douglas. Last year, the real rental rate of capital grew by 2% annually and the

capital to labor ratio by 1%.

Based on this information, what is your best estimate of the growth rate of output per worker?

Please carefully show your calculations. From a historical US perspective, would you say that

this is a good growth rate of GDP per capita?

b. (6 pts.) Still assuming that prices are flexible and the economy is closed (i.e. we are still in

Chapter 3), suppose that the increase in unemployment benefits leads some workers to remain

outside the labor market. One may view this as a reduction in the labor force.

How would you expect this to impact the real rental rate of capital, assuming that the capital

stock is fixed? Carefully explain why, including what, if any, properties of the production function

you base your conclusion on. Would you expect business owners to be in favor or against this

rise in unemployment benefiits?

c. (6 pts.) In the very long run, also the capital stock is flexible. Please describe how you expect

the economy to adjust to its very long run steady state. What happens to the rental rate of

capital over time? What happens to the capital stock per worker?

d. (6 pts.) Let us now contemplate some of the arguments in favor of increasing unemployment

benefits by taking a short-term perspective. That is, we now assume that prices are fixed (i.e.

we are now in the AS/AD framework).

Households, concerned with the uncertainty introduced by the crisis, hold on to money more.

Please explain how you would expect this to impact the aggregate demand curve. If higher

unemployment benefits increase people's confidence in the future (at least you'd have some

income if you lost your job), how would you expect that to impact aggregate demand? Please

include any relevant graphs to highlight your argument.

e. (6 pts.) At the same time, the policy may also impact short-run aggregate supply. Greater un-

employment benefits may make workers demand higher pay, since absent higher pay they would

rather stay at home. That is, we may view this as a negative aggregate supply shock.

Illustrate how you would expect this to impact the economy in the short run in the AS/AD

framework, assuming that these extended unemployment benefits are removed once the crisis is

over. Putting your short-run analysis in subquestions d. and e. together, briefy discuss your

view of the short-run effectiveness of this policy.