Download II. Goals of Chapter 3

Chapter 3
Productivity, Output, and
Employment
I.
Goals of Part 2: The Macroeconomics of
Full Employment
• A) Analyze factors that affect the longerterm 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) Introduce the production function as the
main determinant of output
• B) Discuss the determinants of labor
demand and supply
• C) Equilibrium in the classical model of the
labor market
• D) Unemployment
I.
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How Much Does the Economy Produce?
The Production Function (Sec. 3.1)
A) Factors of production
1. Capital
2. Labor
3. Others (raw materials, land, energy)
4. Productivity of factors depends on technology
and management
B) The production function
1. Y = AF(K, N)
2. Parameter A is “total factor productivity”
C) Application: The production function of the U.S.
economy and U.S. productivity growth
D)
The shape of the production function
• 1. Two main properties of production
functions
• a. Slopes upward output
• b. Slope becomes flatter as input rises
• 2. Graph production function (Y vs. one
input; hold other input and A fixed)
• a. Marginal product of capital, MPK =
Y/K (Figure 3.2)
• b. Marginal product of labor, MPN =
Y/N (Figure 3.2; like text Figure 3.3)
E)
Supply shocks
• 1. Supply shocks affect the amount of output
that can be produced for a given amount of
inputs
• 2. Shocks may be positive (increasing output)
or negative (decreasing output)
• 3. Examples: weather, inventions and
innovations, government regulations, oil prices
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4. Supply shocks shift graph of production
function (Figure 3 )
II.
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
3.5)
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)
• 2. W = MRPN is the same condition as w
= MPN, since W = P  w and MRPN = P 
MPN
• 3. A change in the wage
• 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:
• 3. Size of capital stock
• E) Aggregate labor demand
III.
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The Supply of Labor (Sec. 3.3)
A) Supply of labor is determined by individuals
B) The income-leisure trade-off
C) Real wages and labor supply
1. An increase in the real wage has offsetting income and substitution
effects
2. A pure substitution effect: a one-day rise in the real wage
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
4. The substitution effect and the income effect together: a long-term
increase in the real wage
5. Empirical evidence on real wages and labor supply
D) The labor supply curve (Figure 3.7)
IV.
Labor Market Equilibrium (Sec. 3.4)
• A. Equilibrium: Labor supply equals labor
demand (Figure 3.11)
• 1. Classical model of the labor market—
real wage adjusts quickly
• 2. Determines full-employment level of
employment and market-clearing real
wage
• 3. Factors that shift labor supply or labor
demand affect and 4. Problem with
classical model: can’t study unemployment
• B) Full-employment output
• 1. = AF(K,)
• 2. affected by changes in or production
function (example: supply shock)
• C) Application: output, employment, and
the real wage during oil price shocks
• D) Application: technical change and wage
inequality
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. Participation Rate = Labor Force/Adult
Population
• 5. Employment Ratio = Employed/Adult
Population
• B) Changes in employment status
• 1. Flows between categories
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:
D)
Why there are always unemployed people
• 1. Frictional unemployment
• 2. Structural unemployment
• 3. The natural rate of unemployment
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)/ = 2 (u – )
(3.5)
• C) Why is the Okun’s Law coefficient 2,
and not 1?
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Y/Y = 3 – 2 u
(3.6)