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Chapter 3

Chapter 3. Productivity, Output, and Employment. I. 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)

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Chapter 3

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  1. Chapter 3 Productivity, Output, and Employment

  2. I. 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)

  3. 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

  4. I. 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

  5. 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)

  6. 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 • 4. Supply shocks shift graph of production function (Figure 3 )

  7. 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)

  8. 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

  9. 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

  10. 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

  11. III. 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)

  12. 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

  13. 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

  14. 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

  15. 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:

  16. D) Why there are always unemployed people • 1. Frictional unemployment • 2. Structural unemployment • 3. The natural rate of unemployment

  17. 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? • Y/Y= 3 – 2 u (3.6)

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