Question

In the coordination failure model:

a. Describe an example of a coordination failure problem.

b. What causes business cycles in the coordination failure model?

c. Why money is neutral in the coordination failure model?

d. Should the government act to stabilize output in the coordination failure model?

Answer 1

a. Coordination failure exists when loss is seen in complementary activities. Suppose in a team,  one worker puts extra effort to generate high productivity and other workers also starts working hard after watching him then it lead to high productivity. on the other hand, if one worker puts less/more effort and remaining puts the less effort only then it leads to coordination failure in terms of team work.

b. Business cycles emerge in coordination failure model through the trend of Optimism and Pessimism. Keynes mentioned extraneous events refereed as 'Sunspots' responsible for emergence of business cycles the said model. Such as one sunspot is good equilibrium in term of Optimism i.e. increase in investment, labor supply and output etc.

c. Money neutrality refers to no change in relative prices and behavior of economic agents as well. It affects only nominal variable not the real variables such as output in the economy. If money is a sunspot variable then as increase in money supply will affect output in the economy in long run while in short run money is not neutral.

d. the government should work on stabilizing the economy in terms of smoothening or eliminating the business cycles. It can work on boosting the economy.