ECN 3102 - MACROECONOMICS

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ECN 3102 - MACROECONOMICS. CHAPTER 3: Productivity; Output, and Employment. 1. HOW MUCH DOES THE ECONOMY PRODUCE?. Depends on the production function. 1.1 Factors of production Capital Labor Others – raw material, land, energy

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### ECN 3102 - MACROECONOMICS

CHAPTER 3:

Productivity; Output, and Employment

1. HOW MUCH DOES THE ECONOMY PRODUCE?
• Depends on the production function.

1.1 Factors of production

• Capital
• Labor
• Others – raw material, land, energy
• Productivity of factors depends on technology and management.
2. THE PRODUCTION FUNCTION
• Y = AF(K,N)
• Parameter A is “total factor productivity”

2.1 Application

• Cobb-Douglas production function, for US

Y = A K0.3N0.7

2. THE PRODUCTION FUNCTION (cont.)

2.2 Properties of production function.

Y

K/N

• Slopes upward – more of any input produces more output.
• Slope becomes flatter as input rises: diminishing marginal product as input increases.
2. THE PRODUCTION FUNCTION (cont.)

2.3 Marginal Product of Capital (MPK)

Y

Slope = MPK

K

• MPK =  Y

 K

• Equal to slope of production function.
• MPK is always positive.
• Diminishing marginal product of capital.
2. THE PRODUCTION FUNCTION (cont.)

2.4 Marginal Product of Labor (MPN);

Y

Slope = MPN

N

• MPN =  Y

 N

• Equal to slope of production function.
• MPN is always positive.
• Diminishing marginal product of labor.
3. SUPPLY SHOCKS
• Affect the amount of output that can be produced for a given amount of input.
• Positive shocks:
•  output (example invention & innovation)
• slope of production function  at each level of input if shocks causes parameter A to 
• Negative shocks:
•  output, example bad weathers
• slope of production function  at each level of input if shocks causes parameter A to 
3. SUPPLY SHOCKS (cont.)

Y

+ Shock

- Shock

K

4. DEMAND FOR LABOR
• How much labor do firms want to use?
• Assumptions
• Hold K fixed – short run analysis
• Workers are all alike
• Labor market is competitive
• Firms maximize profits
4. DEMAND FOR LABOR (cont.)

4.1 MPN and Labor Demand (ND)

• MPN is the analysis at the margin.
• It is the benefit of hiring one extra worker in terms of the extra output produced.
4. DEMAND FOR LABOR (cont.)
• Firms’ profit are highest when w = MPN
• Marginal revenue product of labor (MRPN)

MRPN = MPN x P

4. DEMAND FOR LABOR (cont.)

Price (P) = \$ 10 per output

Nominal Wage (W) = \$80 per day

Benefit of hiring an additional worker = MRPN

Cost of an additional worker in dollar = W

Real cost of additional worker = w

w = W/P  real wage

w = 80/10 = 8 output per day

4. DEMAND FOR LABOR (cont.)
• A change in wage
• Nominal wage  to \$60 per day
• P = \$ 10 per output
• w = 60/10 = 6 output per day
4. DEMAND FOR LABOR (cont.)
• How will the reduction of W affect the number of workers firm wants to employ?

We compare the cost and benefit of changing the amount of labor.

4. DEMAND FOR LABOR (cont.)
• Compare the Costs and Benefits of changing Labor
4. DEMAND FOR LABOR (cont.)

4.2 MPN and Labor Demand Curve (ND)

The amount of Labor demand is determined by locating the point on the MPN curve at which the MPN equals the real wage rate :i.e. the amount of L correspond to that point which is the amount of L demanded

MPN / w

real wage

A

w*

MPN / ND

N*

N

4. DEMAND FOR LABOR (cont.)
• Why MPN and ND have the same shape?
• Because MPN curve also shows the amount of labor demanded at any real wage (w).
• Both MPN and ND slopes downward indicates that quantity of labor  as w .

w

ND

N

4. DEMAND FOR LABOR (cont.)

4.3 Factors that shift ND curve

• Note: in W cause a movement along the demand curve. Not a shift in ND.
• Factor that shift Agg. ND curve
5. LABOR SUPPLY (NS)
• NS is determined by individuals:
• Aggregate NS is sum of individuals’ labor supply.
• Individuals NS depends on labor-leisure choice.
5. LABOR SUPPLY (NS) (cont.)

5.1 The Income- Leisure Trade –off

• Utility depends on consumption and leisure.
• Need to compare costs and benefits of working another day
• Cost: Loss of leisure time
• Benefit: More consumption because income is higher
• If benefit of working another day > costs  worker will work another day.
• Worker will keep working additional days until Benefits = Costs
5. LABOR SUPPLY (NS) (cont.)

5.2 Real wage (w) and NS

• Increase in real wage has 2 effects on NS:
• Income effect
• Substitution effect
• Substitution effect of a higher real wage
• Higher w encourages work  NS
• Income effect of a higher real wage
• Higher w increases income  NS
6. LABOR SUPPLY CURVE
•  in the current real wage should raise quantity of labor supplied.
• Labor supply curve (NS) relates quantity of labor supplied to real wage (w).
• NS curve slopes upward because higher wage encourages people to work more.
6. LABOR SUPPLY CURVE (cont.)

NS

w

6.1 Aggregate labor supply

• Aggregate supply of labor is the total amount of labor supplied by everyone in the economy.
• When current w :
• Some people work more hours
• Other people enter the labor force
• Result: Agg. NS curve slopes upward.
• Shape of NS shows a positive relationship between w and amount of labor supplied.

N

6. LABOR SUPPLY CURVE (cont.)

6.2 Factors that shift the Aggregate NS curve

6. LABOR SUPPLY CURVE (cont.)

NS1

anything that has the effect of

making the workers wealthier

Will reduce the amount of labor

Supplied.

w

NS0

NS2

N

• Equilibrium condition: NS = ND
• Classical assumption: real wage (w) adjust quickly to achieve equilibrium.
7. LABOR MARKET EQUILIBRIUM (Classical Model of the Labor Market) (cont.)

w

• N is full-employment level of employment.
• w is market clearing wage.
• Problem with Classical model: can’t study unemployment.

NS

w

ND

N

N

7. LABOR MARKET EQUILIBRIUM (Classical Model of the Labor Market) (cont.)

7.1 What is full-employment level of employment?

• It is the equilibrium level of employment, achieved after complete adjustment of wages and prices.
7. LABOR MARKET EQUILIBRIUM (Classical Model of the Labor Market) (cont.)

7.2 : Effects of Adverse (Negative) Supply Shock in the Labor Market

• This classical supply-demand model is simple.
• It assumes that any worker who wants to work with w can find a job, the model implies zero unemployment, which actually never occurs.

w

NS

A

w1

B

w2

ND1

ND2

N2

N1

N

7. LABOR MARKET EQUILIBRIUM (Classical Model of the Labor Market) (cont.)

7.2 What is full-employment output (Y)?

• The level of output that firms in the economy supply when wages and prices are fully adjusted.
• Defining full-employment output (using production function): Y = AF (K, N)
• Y is affected by changes in N or production function.

LABOR FORCE

EMPLOYED

UNEMPLOYED

8. UNEMPLOYMENT
• 3 categories:
• Employed
• Unemployed
• Not in the labor force
Employed; person who work full time or part time in the past week (or those who are on sick leave or on vacation).
• Unemployed; those who didn’t work during past week or looking for work for past four weeks.
• Not in labor force; those who didn’t work in the past week and didn’t look for work for the last four weeks (full-time students, housewives and retirees).
8. UNEMPLOYMENT (cont.)

8.2 MEASURING UNEMPLOYMENT

• UNEMPLOYMENT RATE

( is the fraction of the labor-force that is unemployed)

• Number of people unemployed x 100

Labor force

• Unemployment rate is at its peak during recessions.
8. UNEMPLOYMENT (cont.)
• PARTICIPATION RATE (the fraction of adult population in L-force)

Labor force x 100

• EMPLOYMENT RATIO (is the employed fraction of the adult population)

Number of people employed x 100

8. UNEMPLOYMENT (cont.)

8.3 TYPES OF UNEMPLOYMENT

• FRICTIONAL UNEMPLOYMENT
• Due to mismatch in the job market.
• People looking for more suitable job.
• Permanent and healthy phenomenon in a growing economy.
• CYCLICAL UNEMPLOYMENT
• Due to changes in economic activity (business cycle).
•  during recession, when output falls,  during expansion.
• Some workers are retrenched.
• Is the difference between u - û
8. UNEMPLOYMENT (cont.)
• STRUCTURAL UNEMPLOYMENT
• Long term and chronic unemployment.
• Demand for labor in certain sector decline. Reallocation of workers takes longer time due to lack of skill.
• Technology advancement and innovation reduces the need of labor.
8. UNEMPLOYMENT (cont.)

8.4 FULL EMPLOYMENT

• Occurs when there is no cyclical unemployment
• All unemployment that exists is frictional and structural unemployment.
• At full employment; unemployment rate (u) = natural rate of unemployment (û).
8. UNEMPLOYMENT (cont.)

8.5 NATURAL RATE OF UNEMPLOYMENT

• The unemployment rate (u) at full employment is known as natural rate of unemployment (û).
• û = frictional + structural unemployment
• The unemployment rate (actual) fluctuates around the natural rate of unemployment.
• u < û , real GDP > potential GDP
• u > û , real GDP < potential GDP

û = frictional + structural unemployment

8. UNEMPLOYMENT (cont.)

8.6 NEGATIVE IMPACT OF UNEMPLOYMENT

• ECONOMY
• Reduces society welfare
• Reduces government development activity
• Retard economic growth
• INDIVIDUAL
• Loss of job and income
• Loss of skill
• Social and political problem
9. OKUN’S LAW
• Relating output and unemployment
• It is a relationship between output (relative to full employment output) and cyclical unemployment.
9. OKUN’S LAW (cont.)
• Okun’s Law: or

(Ŷ – Y)/ Ŷ = 2.5 (u – û)

∆Y/Y = ∆Ŷ/ Ŷ - 2.5 ∆u

• the gap between the economy’s full-employment output and its actual level of output increase by 2% points for each % point the unemployment rate increases.
9. OKUN’S LAW (cont.)
• Why is the Okun’s Law coefficient 2.5, and not 1?
• When cyclical unemployment ↑: labor force falls, hours of work per worker decline, average productivity of labor declines.
• The result is1 % point increase in unemployment rate result in 2.5 % reduction in output.