Transcript The Economy at Full Employment

CHAPTER 7
The Economy at Full
Employment
Copyright © 2012 Pearson
Prentice
Hall.
All rights
reserved.
Copyright
© 2012
Pearson
Prentice
Hall. All rights reserved.
7-1
CHAPTER
The Economy at Full
Employment
7
While immigration is a big issue in the United States, emigration –
the outflow of people – is a major issue in other countries.
PREPARED BY
Brock Williams
Copyright © 2012 Pearson Prentice Hall. All rights reserved.
CHAPTER 7
The Economy at Full
Employment
APPLYING THE CONCEPTS
1
How can changes in the supply of labor affect real
wages?
The Black Death and Living Standards in Old
England
2
Do differences in taxes and government benefits
explain why Europeans work substantially fewer hours
per year than do U.S. workers or the Japanese?
A Nobel Laureate Explains Why Europeans Work
Less Than U.S. Workers or the Japanese
3
Can real business cycle models explain the origin and
persistence of the Great Depression?
Can Labor Market Policies Account for the Great
Depression?
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7-3
CHAPTER 7
The Economy at Full
Employment
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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7-4
CHAPTER 7
The Economy at Full
Employment
7.2
THE PRODUCTION FUNCTION
• 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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7-5
CHAPTER 7
The Economy at Full
Employment
7.2
THE PRODUCTION FUNCTION (cont’d)
 FIGURE 7.1
The Relationship between
Labor and Output with Fixed
Capital
With capital fixed, output
increases with labor input,
but at a decreasing rate.
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CHAPTER 7
The Economy at Full
Employment
7.2
THE PRODUCTION FUNCTION (cont’d)
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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CHAPTER 7
The Economy at Full
Employment
7.2
THE PRODUCTION FUNCTION (cont’d)
 FIGURE 7.2
An Increase in the Stock of
Capital
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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7-8
CHAPTER 7
The Economy at Full
Employment
7.3
WAGES AND THE DEMAND AND
SUPPLY FOR LABOR
 FIGURE 7.3
The Demand and Supply of Labor
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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7-9
CHAPTER 7
The Economy at Full
Employment
7.3
WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont’d)
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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7-10
CHAPTER 7
The Economy at Full
Employment
7.3
WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont’d)
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.
 FIGURE 7.4
Shifts in Labor Demand
and Supply
Shifts to demand and
supply will change
both real wages and
employment.
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CHAPTER 7
The Economy at Full
Employment
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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CHAPTER 7
The Economy at Full
Employment
7.4
LABOR MARKET EQUILIBRIUM AND FULL
EMPLOYMENT
 FIGURE 7.5
Determining Full-Employment
Output
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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7-13
CHAPTER 7
The Economy at Full
Employment
7.5
USING THE FULL-EMPLOYMENT MODEL
Taxes and Potential Output
 FIGURE 7.6
How Employment Taxes
Affect Labor Demand and
Supply
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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CHAPTER 7
The Economy at Full
Employment
APPLICATION
2
A NOBEL LAUREATE EXPLAINS WHY EUROPEANS WORK LESS THAN
U.S. WORKERS OR THE JAPANESE
APPLYING THE CONCEPTS #2: Do differences in taxes and government
benefits explain why Europeans work substantially fewer hours per year
than do U.S. workers or the Japanese?
On average today, the French (and other Europeans) work one-third fewer hours than
do U.S. workers. In the early 1970s Europeans actually worked slightly more hours than
did U.S. workers.
What explains this dramatic turnaround in the space of just 20 years?
Nobel-laureate Edward Prescott of the Federal Reserve Bank of Minneapolis and
Arizona State University attributes the decreases in hours of work in Europe to:
• Increases in the tax burden that ultimately falls on workers.
• Government spending and transfers play a larger role in European economies than
in the United States.
Prescott notes that as the burdens of Social Security and Medicare increase, the United
States may be tempted to increase its tax rates to European levels.
What will happen if we do not make changes in the underlying programs and allow tax
rates to increase?
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7-15
CHAPTER 7
The Economy at Full
Employment
7.5
USING THE FULL-EMPLOYMENT MODEL
Real Business Cycle Theory
• real business cycle theory
The economic theory that emphasizes how shocks to
technology can cause fluctuations in economic activity.
 FIGURE 7.7
How an Adverse
Technology Shock Affects
Labor Demand and Supply
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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7-16
CHAPTER 7
The Economy at Full
Employment
APPLICATION
3
CAN LABOR MARKET POLICIES ACCOUNT FOR THE GREAT DEPRESSION?
APPLYING THE CONCEPTS #3: Can real business cycle models explain the
origin and persistence of the Great Depression?
Real Business Cycle models do not explain the Great Depression
Economists Cole and Ohanian of UCLA modified the standard model to
include other factors.
▪ President Roosevelt’s New Deal allowed firms to collude if they
recognized unions and raised wages.
▪ President Hoover also had polices that raised wages.
Incorporating these factors into the model allow it to explain the origin and
severity of the Great Depression.
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7-17
CHAPTER 7
The Economy at Full
Employment
7.6
DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
International Comparisons
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7-18
CHAPTER 7
The Economy at Full
Employment
7.6
DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT (cont’d)
Crowding Out in a Closed Economy
• crowding out
The reduction in investment (or other component of
GDP) caused by an increase in government spending.
P R I N C I P L E O F O P P O RT U N I T Y C O S T
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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CHAPTER 7
The Economy at Full
Employment
7.6
DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT (cont’d)
Crowding Out in a Closed Economy
 FIGURE 7.8
U.S. Consumption and
Government Spending During
World War II
Increased government
spending crowds out
consumption by
consumers.
The vertical bar highlights
the time period during
which crowding out
occurred.
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7-20
CHAPTER 7
The Economy at Full
Employment
7.6
DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT (cont’d)
Crowding Out in a Closed Economy
 FIGURE 7.9
U.S. Investment and
Government Spending During
World War II
Increased government
spending also crowds out
private investment
spending.
The vertical bar highlights
the time period during
which crowding out
occurred.
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7-21
CHAPTER 7
The Economy at Full
Employment
7.6
DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT (cont’d)
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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CHAPTER 7
The Economy at Full
Employment
KEY TERMS
classical models
full-employment output
closed economy
labor
crowding in
open economy
crowding out
production function
real business cycle theory
real wage
stock of capital
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7-23