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) • 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.

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

input; hold other input and

A

vs. one 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 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

=

MPN MRPN

, since is the same condition as

w 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.

The Supply of Labor (Sec. 3.3)

• A) • B) Supply of labor is determined by individuals 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.

• 4.

The substitution effect and the income effect together: a long-term increase in the real wage • 5.

A pure income effect: winning the lottery 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?



Y

/

Y

= 3 – 2 

u

(3.6)