Transcript Chapter 1

Chapter 3
Productivity,
Output, and
Employment
Copyright © 2012 Pearson Education Inc.
The Production Function

Factors of production are inputs to
the production process:
capital (factories, machines);
 labour (workers);
 raw materials and energy;
 technology and management.

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The Production Function
(continued)

A production function is a
mathematical expression relating
the amount of output produced to
quantities of capital and labour
utilized.
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The Production Function
(continued)
Y  AF(K, N)
Y is real output produced
A is a number measuring overall
productivity
K is the quantity of capital used (capital
stock)
N is the number of workers employed
F is a function relating Y to K and N
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The Production Function
(continued)
Total factor productivity
(productivity) is a measure of
overall effectiveness with which
capital and labour are used.
 An improvement in production
technology allows capital and
labour to be utilized more
effectively.

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The Production Function
(continued)

Properties of production functions:
they slope upward from left to right;
 the slope becomes flatter from left to
right.

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The Marginal Product of
Capital

The marginal product of capital
(MPK) is the increase in output
produced resulting from a one-unit
increase in the capital stock (other
factors held constant).
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The Marginal Product of
Capital (continued)

The MPK equals the slope of the
line tangent to the production
function at a given point.
ΔY
MPK 
ΔK
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The Marginal Product of
Capital (continued)

The properties of the production
function:
the MPK is positive;
 the MPK declines as the capital stock
increases.

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The Marginal Product of
Capital (continued)

Diminishing marginal productivity
is the tendency for the marginal
product of capital to decline as the
amount of capital increases.
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The Marginal Product of
Labour

The marginal product of labour
(MPN) is the increase in output
produced by each additional unit of
labour (other factors held
constant).
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The Marginal Product of
Labour (continued)
ΔY
MPN 
ΔN
The marginal productivity of labour
is diminishing for similar reasons
as with capital.
 The properties of the production
function are the same.

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The Production Function
Supply Shocks
A supply shock (productivity
shock) is a change in an
economy’s production function.
 A positive (beneficial) shock raises
the amount of output which can be
produced with each capital-labour
combination.

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The Production Function
Supply Shocks (continued)
A negative (adverse) shock lowers
the amount of output which can be
produced with each capital-labour
combination.
 Positive shocks shift the production
function upward.
 Negative shocks shift the
production function downward.

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The Production Function
Supply Shocks (continued)
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The Demand for Labour
Let’s assume the capital stock is
fixed in the short run. It is longlived and has been built over
years.
 Let’s assume the amount of labour
is variable in the short run. Firms
may employ and lay off workers
without much notice.

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The Demand for Labour
(continued)

Also let’s assume that:
Workers are all alike.
 The wage is determined in a
competitive market.
 A firm employs workers to earn the
highest possible level of profit (up to
MPN equals wage).

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The MPN and the Labour
Demand

The MPN measures the benefit of
employing an additional worker in
terms of the extra output
produced.
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The MPN and the Labour
Demand (continued)

The marginal revenue product of
labour (MRPN) measures the
benefit of employing an additional
worker in terms of the extra
revenue produced.
MRPN  P  MPN
P is the price of output
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The MPN and the Labour
Demand (continued)
To an employer the benefit is
MRPN and the cost is the nominal
wage (W).
 In real terms the benefit is MPN
and the cost is the real wage (w) the nominal wage (W) divided by
the price of output (P).

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The MPN and the Labour
Demand Curve
The relationship between the real
wage and the quantity of labour
demanded is negative.
 The MPN curve is downward
sloping due to diminishing MPN.

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The MPN and the Labour
Demand Curve (continued)
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The Labour Demand Curve
Shifters
Changes in the real wage are
represented as movements along
the labour demand curve.
 The labour demand curve shifts in
response to factors that change
the amount of labour that firms
want to employ at any given level
of real wage.

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The Labour Demand Curve
Shifters (continued)
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Aggregate Labour Demand
Aggregate labour demand is the
sum of the labour demands of all
the firms in the economy.
 The aggregate labour demand
curve looks the same and behaves
the same as a labour demand
curve for an individual firm.

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The Supply of Labour
Aggregate supply of labour is the
sum of labour supplied by
everyone in the economy.
 Each person must decide how
much time to work for income
versus how much time to allocate
for leisure (off–work activities).

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The Supply of Labour
(continued)
The utility (happiness) from
income for one more hour at work
is compared to the cost (lost
utility) of one less hour of leisure.
 Utility is maximized when these
values are the same.

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Real Wages and Labour
Supply

The substitution effect of a higher
real wage is the tendency of
workers to supply more labour and
reduce leisure hours in response to
a higher real wage.
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Real Wages and Labour
Supply (continued)

The income effect of a higher real
wage is the tendency of workers to
supply less labour and increase
leisure hours as they enjoy higher
incomes.
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Real Wages and Labour
Supply (continued)
The two effects work in opposite
directions.
 The substitution effect of a higher
real wage is an increase in the
quantity of labour supplied.
 The income effect is a decrease in
the quantity of labour supplied.

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Real Wages and Labour
Supply (continued)

The longer an increase in the real
wage is expected to last, the larger
is the income effect.
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The Labour Supply Curve

The labour supply
curve is the curve
which relates the
amount of labour
supplied to the
current real wage
(other factors held
constant, including
the real wage
expected in the
future).
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The Labour Supply Curve
(continued)

The labour supply
curve is upward
sloping. An
increase in the
current real wage
leads to an
increase in labour
supplied.
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The Labour Supply Curve
(continued)

Except the real
wage, any factor
which changes the
amount of labour
supply will shift
the labour supply
curve.
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Aggregate Labour Supply

Aggregate labour supply is the
total amount of labour supplied in
the economy.
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Aggregate Labour Supply
(continued)

An increase in the current
economy wide real wage raises the
aggregate quantity of labour
supplied:
people already working supply more
hours;
 some people are induced to join the
labour force.

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Labour Market Equilibrium

The classical model of the labour
market assumes that the real
wage adjusts quickly to equate
labour supply and labour demand.
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Labour Market Equilibrium
(continued)
The equilibrium level of
employment after the complete
adjustment of wages and prices is
full-employment level of
employment ( N ).
 The corresponding market clearing
real wage is ( w ).

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Labour Market Equilibrium
(continued)

The
corresponding
market
clearing real
wage is ( w ).
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Labour Market Equilibrium
(continued)

Aggregate labour
demand or supply
curve shifters affect:
 the equilibrium
real wage;
 the fullemployment level
of
unemployment.
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Labour Market Equilibrium
(continued)
The drawback of the model is that
it implies that there is zero
unemployment.
 Possible explanations of
unemployment:

The real wage could be slow to
adjust.
 Matching people to jobs can be a time
consuming process.

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Full-Employment Output

Full-employment output (potential
output), Y , the level of output that
firms in the economy supply when
wages and prices are fully
adjusted.
Y  AF(K,N)
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Full-Employment Output
(continued)

Effects of an adverse supply
shock:
The output is reduced directly by
reduction in the productivity measure
A.
 The MPN falls, employment N falls,
full employment output Y falls.

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Unemployment
An employed person is someone
who worked full-time or part-time
during the past week.
 An unemployed person is someone
who did not work during the past
week, but who had actively sought
work in the previous four weeks,
and was available for work.

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Unemployed
Unemployment (continued)


Someone not in the labour force is a person
who did not work during the past week and
did not look for work during the past four
weeks.
The labour force is all employed and
unemployed workers. (Aug 2010 – 18.7 million)
Employed
(Aug 2010 – 17.2 million)
Unemployed
Not In Labour
Force
(Aug 2010 – 9.1 million)
(Aug 2010 – 1.5 million)
Working age population (Aug 2010 – 27.8 million)
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Unemployment (continued)

The unemployment rate is the fraction
of the labour force that is unemployed.
(Aug 2010 – 5.4%)


The participation rate is the fraction of
the labour force in the working-age
population. (Aug 2010 – 67.4%)
The employment ratio is the fraction of
the employed in the working-age
population. (Aug 2010 – 62.0%)
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Changes in Employment
Status
The labour market is in a constant
state of flux. Workers lose and find
jobs continuously.
 61% of unemployed stay
unemployed the following month.

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Changes in Employment
Status (continued)

Some workers become
discouraged workers – people that
are so discouraged by lack of
success at finding a job that they
stop searching.
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How Long are People
Unemployed?

An unemployment
spell is the length
of time that an
individual is
constantly
unemployed. Its
length is called the
duration of the
unemployment
spell.
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How Long are People
Unemployed? (continued)
Most unemployment spells are of
short duration, about two month
or less.
 Most people who are unemployed
on a given date are experiencing
unemployment spells with long
duration.

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Frictional Unemployment

Frictional unemployment arises as
workers search for suitable jobs
and firms search for suitable
workers.

The search and match process takes
time.
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Structural Unemployment

Structural unemployment is a
long-term and chronic
unemployment that exists when
the economy is not in a recession.
Unskilled or low skilled workers are
unable to find long-term jobs.
 Reallocation of labour among
industries takes time.

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The Natural Rate of
Unemployment
The natural rate of unemployment
( u ) is the rate of unemployment
that prevails when output and
employment are at their fullemployment levels.
 The natural rate of unemployment
exist due to frictional and
structural causes.

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Cyclical Unemployment

Cyclical unemployment is the
difference between actual and
natural unemployment rates
(u  u )
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Okun’s Law

According to Okun’s law the gap
between an economy’s fullemployment and actual levels of
output increases by about 2
percentage points for every 1
percentage point increase in the
unemployment rate.
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Okun’s Law (continued)
Y Y
 2(u  u )
Y

Okun’s law can also be expressed
as:
ΔY
 3  2 u
Y
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