Transcript 7. The Economy at Full Employment

Economics
NINTH EDITION
Chapter 7
The Economy at Full
Employment
Prepared by Brock Williams
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Learning Objectives
7.1 Identify the key assumption of classical models in macroeconomics.
7.2 Explain the concept of diminishing returns to labor.
7.3 Analyze how shifts in demand and supply affect wages and
employment.
7.4 Explain how full employment is determined in a classical model.
7.5 Describe how changes in taxes can affect full employment.
7.6 Explain how countries must divide output across different uses.
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7.1 WAGE AND PRICE FLEXIBILITY
AND FULL EMPLOYMENT
• Classical models
Economic models that assume wages and prices adjust freely to changes in demand
and supply.
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7.2 THE PRODUCTION FUNCTION (1 of 4)
• Production function
The relationship between the level of output of a good and the factors of production that
are inputs to production.
• Stock of capital
The total of all machines, equipment, and buildings in an entire economy.
• Labor
Human effort, including both physical and mental effort, used to produce goods and
services.
When there are only two factors of production, capital and labor, the production function
is written as follows:
Y = F(K,L)
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7.2 THE PRODUCTION FUNCTION
With capital fixed, output
increases with labor input,
but at a decreasing rate.
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(2 of 4)
7.2 THE PRODUCTION FUNCTION
(3 of 4)
PRINCIPLE OF DIMINISHING RETURNS
Suppose output is produced with two or more inputs, and we increase one input
while holding the other input or inputs fixed. Beyond some point—called the point of
diminishing returns—output will increase at a decreasing rate.
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7.2 THE PRODUCTION FUNCTION
When the capital increases
from K1 to K2, the production
function shifts up.
At any level of labor input, the
level of output increases.
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(4 of 4)
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (1 of 3)
Together, the demand
and supply for labor
determine the level of
employment and the
real wage.
• Real wage
The wage rate paid
to employees
adjusted for changes
in the price level.
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7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (2 of 3)
Labor Market Equilibrium
Panel C of Figure 7.3 puts the demand and
supply curves together.
At a wage of $15 per hour, the amount of labor
firms want to hire—7,500 workers—will be equal
to the number of people who want to work—
7,500 workers.
This is the labor market equilibrium: The quantity
demanded for labor equals the quantity supplied.
Together, the demand and supply curves
determine the level of employment in the
economy and the level of real wages.
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7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (3 of 3)
Changes in Demand
and Supply
MARGINAL PRINCIPLE
Increase the level of an activity as long as its marginal benefit
exceeds its marginal cost. Choose the level at which the marginal
benefit equals the marginal cost.
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APPLICATION 1
THE BLACK DEATH AND LIVING STANDARDS IN OLD ENGLAND
APPLYING THE CONCEPTS #1: How can changes in the supply of labor affect real
wages?
According to the research of Gregory Clark of the UC, Davis, the level of real wages for laborers
in England was nearly the same in 1200 as it was in 1800. Yet, during the period from 1350 to
1550, they were higher—nearly 75 percent higher in 1450, for instance, than in 1200.
Why were real wages temporarily so high during this period?
• The simple answer was the bubonic plague—also known as the Black Death
• Arrived from Asia in 1348 and caused a long decline in total population through the 1450s.
• With fewer workers, there was less labor supplied to the market. The result was higher real wages.
In the era before consistent and rapid technological advance, changes in population was the
primary factor controlling living standards. As the economist Thomas Malthus (1766–1834)
observed, social maladies such as the Black Death would temporarily raise living standards until
higher living standards led to increased population.
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7.4 LABOR MARKET EQUILIBRIUM AND
FULL EMPLOYMENT
Panel B determines the equilibrium level of
employment at L and the real wage rate of W.
Full-employment output in Panel A is Y.
• Full-employment output
The level of output that results when the
labor market is in equilibrium and the
economy is producing at full employment.
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7.5 USING THE FULL-EMPLOYMENT
MODEL (1 of 2)
Taxes and Potential
Output
In Panel A, a tax burden on
labor shifts the labor demand
curve to the left and leads to
lower wages and reduced
employment.
In Panel B, the supply curve
for labor is vertical, which
means that wages fall but
employment does not change.
•
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7.5 USING THE FULL-EMPLOYMENT
MODEL (2 of 2)
Real Business Cycle
Theory
• Real business cycle theory
The economic theory that
emphasizes how shocks to
technology can cause
fluctuations in economic activity.
An adverse shock to technology
will decrease the demand for
labor.
As a result, both real wages and
employment fall as the market
equilibrium moves from a to b.
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APPLICATION 2
DO EUROPEAN SOCCER STARS CHANGE CLUBS TO REDUCE THEIR
TAXES?
APPLYING THE CONCEPTS #2: What evidence is there that taxes on high paid soccer
stars in Europe affect their location decisions among countries?
In 2009, a Portuguese soccer star moved from Manchester United in the United Kingdom to Real Madrid
in Spain. Many speculated that the reason he moved was to avoid a top United Kingdom tax rate of 50
percent in favor of a flat 24 percent rate (with no deductions) created to entice foreigners to locate in
Spain. While this is an interesting anecdote, is there any other evidence that the very top earners will
move to countries with lower tax rates?
In an interesting study, economists Henrik Jacobsen Kleven, Camille Landais,and Emmanuel Saez used
changes in the market for international soccer stars to test for the effects of tax rates. Prior to 1995, the
top European soccer clubs had limits on the number of foreign players on any one team. The European
Court of Justice, however, ruled that these limits violated the treaty of the European community. The
economists found that prior to 1995, taxes on high earners did not have much effect on mobility of soccer
stars, but after 1995, top tax rates did matter.
This type of evidence suggests that countries may not only be in competition for top athletes, but also for
other highly paid individuals—from tennis players to corporate executives.
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APPLICATION 3
GOVERNMENT POLICIES AND SAVINGS RATES
APPLYING THE CONCEPTS #3: What explains Singapore’s high savings rate?
•
•
•
•
In the United States, private consumption plus government consumption totals
84 percent of GDP. In Singapore, total consumption from the private sector and
the government is only 47 percent.
The World Bank estimates Singapore’s gross savings rate at 48 percent,
compared to Hong Kong, which is only 27 percent.
Singapore requires that all workers save a very high percentage of their income
in government accounts called the Central Provident Fund.
Singapore does not have a U.S. style Social Security system and the citizens
rely on this system to finance their retirement years.
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7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(1 of 5)
International Comparisons
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7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(2 of 5)
Crowding Out in a Closed Economy
• Crowding out
The reduction in investment (or other component of GDP) caused by an increase in
government spending.
PRINCIPLE OF OPPORTUNITY COST
The opportunity cost of something is what you sacrifice to get it.
• Closed economy
An economy without international trade.
output = consumption + investment + government purchases
Y=C+I+G
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7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(3 of 5)
Crowding Out in a Closed
Economy
Increased government spending
crowds out consumption by
consumers.
The vertical bar highlights the time
period during which crowding out
occurred.
SOURCE: U.S. Department of
Commerce.
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7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(4 of 5)
Crowding Out in a Closed
Economy
Increased government spending also
crowds out private investment spending.
The vertical bar highlights the time
period during which crowding out
occurred.
SOURCE: U.S. Department of
Commerce.
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7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(5 of 5)
Crowding Out in an Open Economy
• Open economy
An economy with international trade.
Y = C + I + G + NX
Increased government spending need not crowd out either consumption or investment. It
could lead to reduced exports and increased imports.
Crowding in
• Crowding in
The increase of investment (or other component of GDP) caused by a decrease in
government spending.
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KEY TERMS
Classical models
Closed economy
Crowding in
Crowding out
Full-employment output
Labor
Open economy
Production function
Real business cycle theory
Real wage
Stock of capital
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