A Brief Note on the Macroeconomic Consequences of Random Production Failures

Abstract

It is now commonplace for macroeconomists to include random error terms in the specification of aggregate production functions, but the microfoundations for such residual fluctuations in national output are seldom explored in much detail. One explanation is that workers who expend the effort required to produce positive output under "normal" conditions will nevertheless "fail" from time to time. If it is difficult to monitor individual effort, however, and capitalists are unable to differentiate between random failure and the absence of effort with complete confidence, variations in the failure rate will have important macroeconomic consequences. This note outlines a simple discrete time model of the labor market that incorporates these features and explores, on the basis of its stationary equilibria, the broader ramifications of breakdowns in production.

JEL Classification: E23