Transcript Document

Economic Fluctuations
© 2003 South-Western/Thomson Learning
Can the Classical Model Explain
Economic Fluctuations?
•Shifts in Labor Demand
•Shifts in Labor Supply
Shifts in Labor Demand
• Shifts in labor demand not very large
from year to year
• Classical model cannot explain realworld economic fluctuations through
shifts in labor demand
Shifts in Labor Demand
Real
Wage
Rate
Labor
Supply
E
$15
12
F
Normal
Labor
Demand
Recession
Labor
Demand?
70
Million
100
Million
Employment
Shifts in Labor Supply
• Sudden shifts in labor supply are
unlikely
• Thus, the classical model cannot
explain real-world economic
fluctuations through shifts in labor
supply.
Shifts in Labor Supply
Real
Wage
Rate
Recession
Labor
Supply?
G
$18
E
15
Normal
Labor
Supply
Labor
Demand
70
Million
100
Million
Employment
Classical Model Cannot Explain
Economic Fluctuations
• We cannot explain the facts of short-run
economic fluctuations with a model useful
for the long-run
• The classical model assumes the market
always clears,
–it does a poor job of explaining the economy
in the short run
Economic Fluctuations:
A More Realistic View
• Opportunity Costs and Labor Supply
• Firms’ Benefits from Hiring: The Labor
Demand Curve
• The Meaning of Labor Market Equilibrium
• The Labor Market When Output Is Below
Potential
• The Labor Market When Output Is Above
Potential
Economic Fluctuations:
A More Realistic View
Disequilibrium
A situation in which a market does not
clear - quantity supplied is not equal to
quantity demanded.
Opportunity Cost and
Labor Supply
At every point along the labor supply
curve, the wage rate tells us the
opportunity cost of working for the
last worker to enter the labor force.
Opportunity Cost and
Labor Supply
Real
Wage
Rate
LS
E
$15
Opportunity cost to
100-millionth worker
is $15 per hour
F
12
Opportunity
cost to 70 millionth worker
is $12 per hour
70
Million
100
Million
Employment
Firms’ Benefits from Hiring:
The Labor Demand Curve
At every point along the labor demand
curve, the wage rate tells us the benefit
obtained by some firm from the last
worker hired.
Firms’ Benefits from Hiring:
The Labor Demand Curve
Real
Wage
Rate
$15
Benefit from hiring 100millionth worker is
Benefit from hiring
$15 per hour
130-millionth
worker is
E
$12 per hour
K
12
LD
100
Million
130 Employment
Million
The Meaning of Labor
Market Equilibrium
At the equilibrium level of employment,
all opportunities for mutually beneficial
trade in the labor market have been
exploited.
The Meaning of Labor
Market Equilibrium
Real
Wage
Rate
LS
G
$18
E
15
12
J
F
K
LD
Employment
in a recession
70
Million
Employment
in a boom
100
Million
130 Employment
Million
The Labor Market: Output
Below Potential
During a recession, the labor market is
in disequilibrium, and the benefit from
hiring another worker exceeds the
opportunity cost to that worker.
The Labor Market: Output
Below Potential
In recessions, there are incentives to
increase the level of employment
because
•the benefit to firms from additional employment
exceeds the opportunity cost to workers
•these incentives help explain why recessions do
not last forever
The Labor Market: Output
Above Potential
In booms, there are incentives to decrease
the level of employment because
•the benefit to firms from some who have been
hired is smaller than the opportunity cost to
those workers.
•These incentives help explain why booms do not
last forever.
What Triggers
Economic Fluctuations?
• A Very Simple Economy vs.
• The Real-World Economy
• Shocks That Push the Economy Away
from Equilibrium
– Spending shock: a change in spending that
ultimately affects the entire economy
What Triggers
Economic Fluctuations?
In the short run, we need to look
carefully at the problems of
coordinating production, trade, and
consumption in an economy with
hundreds of millions of people and
tens of millions of businesses.
The Economics
of Slow Adjustment
•Adjustment in a Boom
•Adjustment in a Recession
•The Speed of Adjustment
Adjustment in a Boom
When a positive shock causes a boom,
firms operate - temporarily - at abovenormal rates of utilization. As a
consequence
• employment rises above its normal, fullemployment level.
Adjustment in a Boom
Over time, firms that have experienced
an increase in demand will return to
normal utilization rates, and
employment will fall back to its normal,
full-employment level.
Adjustment in a Recession
When an adverse shock causes a
recession, firms operate - temporarily at below-normal rates of utilization.
As a consequence
• employment drops below its normal, fullemployment level.
Adjustment in a Recession
Over time, firms that have experienced
a decrease in demand will return to
normal utilization rates, and
employment will rise back to its
normal, full-employment level.
The Speed of Adjustment
Job-searching behavior by firms and
workers is just one explanation for the
slow pace of adjustment back to full
employment.
Where Do We
Go from Here?
•In the short run, we have seen that
spending shocks to the economy affect
production - usually in a specific sector.
•If we want to understand fluctuations,
we need to take a close look at
spending.