Download M03_ABEL4987_7E_IM_C03

Chapter 3 Productivity, Output, and Employment

I.
Learning Objectives
Goals of Part 2: The Macroeconomics of Full Employment
A. Analyze factors that affect the longer-term performance of the economy
B. Develop a theoretical model of the macroeconomy
1. Three markets
a. Labor market (this chapter)
b. Goods market (Ch. 4)
c. Asset market (Ch. 7)
II.
Goals of Chapter 3
A.
B.
C.
D.
E.
F.

I.
Discuss production function properties and changes (Section 3.1)
Discuss factors that affect the demand for labor (Section 3.2)
Discuss the factors that affect the supply of labor (Section 3.3)
Identify factors that affect labor market equilibrium (Section 3.4)
Explain how the unemployment rate is measured and describe changes in employment status
(Section 3.5)
Explain the significance of Okun’s law (Section 3.6)
Notes
How Much Does the Economy Produce? The Production Function (Sec. 3.1)
A. Factors of production
1. Capital (K)
2. Labor (N)
3. Others (raw materials, land, energy)
4. Productivity of factors depends on technology and management
B. The production function
1. Y  AF(K, N)
(3.1)
2. Parameter A is “total factor productivity” (the effectiveness with which capital and labor
are used)
C. Application: The production function of the U.S. economy and U.S. productivity growth
1. Cobb-Douglas production function works well for U.S. economy:
Y  A K 0.3 N 0.7
2. Data for U.S. economy—text Table 3.1
©2014 Pearson Education
(3.2)
Chapter 3 Productivity, Output, and Employment
31
3. Productivity growth calculated using production function
a. Productivity moves sharply from year to year
b. Productivity grew rapidly in the second half of the 1990s, but grew much more slowly in
the 2000s
D. The shape of the production function
1. Two main properties of production functions
a. Slopes upward: more of any input produces more output
b. Slope becomes flatter as input rises: diminishing marginal product as input increases
2. Graph production function (Y vs. one input; hold other input and A fixed)
a. Marginal product of capital, MPK  Y/K (Figure 3.1; Key Diagram 1; like text
Figure 3.2)
Figure 3.1
(1) Equal to slope of production function graph (Y vs. K)
(2) MPK always positive
(3) Diminishing marginal productivity of capital—MPK declines as K rises
b. Marginal product of labor, MPN  Y/N (Figure 3.2; like text Figure 3.3)
Figure 3.2
(1) Equal to slope of production function graph (Y vs. N)
(2) MPN always positive
(3) Diminishing marginal productivity of labor
©2014 Pearson Education
32
Abel/Bernanke/Croushore • Macroeconomics, Global Edition, Eighth Edition
E. Supply shocks
1. Supply shock  productivity shock  a change in an economy’s production function
2. Supply shocks affect the amount of output that can be produced for a given amount of inputs
3. Shocks may be positive (increasing output) or negative (decreasing output)
4. Examples: weather, inventions and innovations, government regulations, oil prices
5. Supply shocks shift graph of production function (Figure 3.3; like text Figure 3.4)
Figure 3.3
a. Negative (adverse) shock: Usually slope of production function decreases at each level of
input (for example, if shock causes parameter A to decline)
b. Positive shock: Usually slope of production function increases at each level of output (for
example, if parameter A increases)
.
The Demand for Labor (Sec. 3.2)
A. How much labor do firms want to use?
1. Assumptions
a. Hold capital stock fixed—short-run analysis
b. Workers are all alike
c. Labor market is competitive
d. Firms maximize profits
2. Analysis at the margin: costs and benefits of hiring one extra worker (Figure 3.4; like text
Figure 3.5)
Figure 3.4
©2014 Pearson Education,
Chapter 3 Productivity, Output, and Employment
33
a. If real wage (w)  marginal product of labor (MPN), the firm is paying the marginal
worker more than the worker produces, so the firm should reduce the number of workers
to increase profits
b. If w  MPN, the marginal worker produces more than he or she is being paid, so the firm
should increase the number of workers to increase profits
c. Firms’ profits are highest when w  MPN
B. The marginal product of labor and labor demand: an example
1. Example: The Clip Joint—setting the nominal wage equal to the marginal revenue product
of labor
MRPN  P  MPN
(3.3)
2. W  MRPN is the same condition as w  MPN, since W  P  w and MRPN  P  MPN
3. A change in the wage
a. Begin at equilibrium where W  MRPN
b. A rise in the wage rate means W  MRPN, unless N is reduced so the MRPN rises
c. A decline in the wage rate means W  MRPN, unless N rises so the MRPN falls
C. The marginal product of labor and the labor demand curve
1. Labor demand curve shows relationship between the real wage rate and the quantity of labor
demanded
2. It is the same as the MPN curve, since w  MPN at equilibrium
3. So the labor demand curve is downward sloping; firms want to hire less labor, the higher the
real wage
D. Factors that shift the labor demand curve
1. Note: A change in the wage causes a movement along the labor demand curve, not a shift of
the curve
2. Supply shocks: Beneficial supply shock raises MPN, so shifts labor demand curve to the
right; opposite for adverse supply shock
3. Size of capital stock: Higher capital stock raises MPN, so shifts labor demand curve to the
right; opposite for lower capital stock
E. Aggregate labor demand (Figure 3.5)
Figure 3.5
1. Aggregate labor demand is the sum of all firms’ labor demand
©2014 Pearson Education
34
Abel/Bernanke/Croushore • Macroeconomics, Global Edition, Eighth Edition
2. Same factors (supply shocks, size of capital stock) that shift firms’ labor demand cause shifts
in aggregate labor demand
III. The Supply of Labor (Sec. 3.3)
A. Supply of labor is determined by individuals
1. Aggregate supply of labor is sum of individuals’ labor supply
2. Labor supply of individuals depends on labor-leisure choice
B. The income-leisure trade-off
1. Utility depends on consumption and leisure
2. Need to compare costs and benefits of working another day
a. Costs: Loss of leisure time
b. Benefits: More consumption, since income is higher
3. If benefits of working another day exceed costs, work another day
4. Keep working additional days until benefits equal costs
C. Real wages and labor supply
1. An increase in the real wage has offsetting income and substitution effects
a. Substitution effect of a higher real wage: Higher real wage encourages work, since the
reward for working is higher
b. Income effect of a higher real wage: Higher real wage increases income for the same
amount of work time, and with higher income, the person can afford more leisure, so will
supply less labor
2. A pure substitution effect: a one-day rise in the real wage
a. A temporary real wage increase has just a pure substitution effect, since the effect on
wealth is negligible
3. A pure income effect: winning the lottery
a. Winning the lottery doesn’t have a substitution effect, because it doesn’t affect the reward
for working
b. But winning the lottery makes a person wealthier, so a person will both consume more
goods and take more leisure; this is a pure income effect
4. The substitution effect and the income effect together: a long-term increase in the real wage
a. The reward to working is greater: a substitution effect toward more work
b. But with a higher wage, a person doesn’t need to work as much: an income effect toward
less work
c. The longer the high wage is expected to last, the stronger the income effect; thus labor
supply will increase by less or decrease by more than for a temporary reduction in the
real wage
5. Empirical evidence on real wages and labor supply
a. Overall result: Labor supply increases with a temporary rise in the real wage
b. Labor supply falls with a permanent increase in the real wage
D. The labor supply curve (Figure 3.6; like text Figure 3.7)
1.
Increase in the current real wage should raise quantity of labor supplied
2.
Labor supply curve relates quantity of labor supplied to real wage
©2014 Pearson Education,
Chapter 3 Productivity, Output, and Employment
35
Figure 3.6
3. Labor supply curve slopes upward because higher wage encourages people to work more
E. Factors that shift the labor supply curve
1. Wealth: Higher wealth reduces labor supply (shifts labor supply curve to the left; text
Fig. 3.8)
2. Expected future real wage: Higher expected future real wage is like an increase in wealth,
so reduces labor supply (shifts labor supply curve to the left)
F.
Aggregate labor supply
1. Aggregate labor supply rises when current real wage rises
a. Some people work more hours
b. Other people enter labor force
c. Result: Aggregate labor supply curve slopes upward
2. Factors increasing labor supply
a. Decrease in wealth
b. Decrease in expected future real wage
c. Increase in working-age population (higher birth rate, immigration)
d. Increase in labor force participation (increased female labor participation, elimination of
mandatory retirement)
IV. Labor Market Equilibrium (Sec. 3.4)
A. Equilibrium: Labor supply equals labor demand (Figure 3.7; Key Diagram 2; like text
Figure 3.9)
Figure 3.7
©2014 Pearson Education
36
Abel/Bernanke/Croushore • Macroeconomics, Global Edition, Eighth Edition
1. Classical model of the labor market—real wage adjusts quickly (later, in Chapter 11, look at
other models of labor market in which real wage does not adjust quickly)
2. Determines full-employment level of employment N and market-clearing real wage w
3. Factors that shift labor supply or labor demand affect N and w
4. Problem with classical model: can’t study unemployment
B. Full-employment output
1. Full-employment output  potential output  Y level of output when labor market is in
equilibrium
2. Y  AF(K, N )
(3.4)
3. Y affected by changes in N or production function (example: supply shock, text Fig. 3.10)
C. Application: output, employment, and the real wage during oil price shocks
1. Sharp oil price increases in 1973–1974, 1979–1980, 2003–2008 (text Fig. 3.11)
2. Adverse supply shock—lowers labor demand, employment, the real wage, and the fullemployment level of output
3. First two cases: U.S. economy entered recessions
4. Research result: 10% increase in price of oil reduces GDP by 0.4 percentage points
V.
Unemployment (Sec. 3.5)
A. Measuring unemployment
1. Categories: employed, unemployed, not in the labor force
2. Labor Force  Employed  Unemployed
3. Unemployment Rate  Unemployed/Labor Force
4. Table 3.4 shows current data
4. Participation Rate  Labor Force/Adult Population
5. Employment Ratio  Employed/Adult Population
B. Changes in employment status
1. Flows between categories (text Fig. 3.12)
2. Discouraged workers: people who have become so discouraged by lack of success at finding
a job that they stop searching
C. How long are people unemployed?
1. Most unemployment spells are of short duration
a. Unemployment spell  period of time an individual is continuously unemployed
b. Duration  length of unemployment spell
2. Most unemployed people on a given date are experiencing unemployment spells of long
duration
3. Reconciling 1 and 2—numerical example:
a. Labor force  100; on the first day of every month, two workers become unemployed for
one month each; on the first day of every year, four workers become unemployed for one
year each
b. Result: 28 spells of unemployment during year; 24 short (one month), four long (one
year); so most spells are short
©2014 Pearson Education,
Chapter 3 Productivity, Output, and Employment
37
c. At any date, unemployment  six; four have long spells (one year), two have short spells
(one month); so most unemployed people on a given date have long spells
D. Application: Unemployment Duration and the 2007-2009 Recession
1. The mean duration of unemployment always rises in recessions but in the 2007-2009 the rise
was larger than ever before (text Fig. 3.13)
2. Four possible explanations for the increase include measurement issues, the extension of
unemployment benefits, very large job losses, and a weak economic recovery
E. Why there are always unemployed people
1. Frictional unemployment
a. Search activity of firms and workers due to heterogeneity
b. Matching process takes time
2. Structural unemployment
a. Chronically unemployed: workers who are unemployed a large part of the time
b. Structural unemployment: the long-term and chronic unemployment that exists even
when the economy is not in a recession
c. One cause: Lack of skills prevents some workers from finding long-term employment
d. Another cause: Reallocation of workers out of shrinking industries or depressed regions;
matching takes a long time
3. The natural rate of unemployment
a. u natural rate of unemployment; when output and employment are at full-employment
levels
b. u  frictional  structural unemployment
c. Cyclical unemployment: difference between actual unemployment rate and natural rate
of unemployment (u  u )
4. In touch with data and research: labor market data in Kazakhstan
a. Labor market report
(1) Survey: unemployment, employment
(2) Establishment survey: jobs
VI. Relating Output and Unemployment: Okun’s Law (Sec. 3.6)
A. Relationship between output (relative to full-employment output) and cyclical unemployment
B. ( Y  Y)/ Y  2 (u  u )
(3.5)
C. Why is the Okun’s Law coefficient 2, and not 1?
1. Other things happen when cyclical unemployment rises: Labor force falls, hours of work per
worker decline, average productivity of labor declines
2. Result is 2% reduction in output associated with 1 percentage point increase in
unemployment rate
D. Alternative formulation if average growth rate of full-employment output is 3%:
1. Y/Y  3  2 u
2. Text Fig. 3.14 shows U.S. data
©2014 Pearson Education
(3.6)