The Economy at Full Employment

1
The Economy at Full Employment

• Three Variables we look at
• Total Output, or Real GDP.
• Output per capita.
• Productivity measured by output per hour of work.

2
The Production Function.Y f(hN,K,NR, T)

• where
• N the number of workers.
• h the average number of hours worked.
• K the capital stock.
• NR the natural resources used in production.
• T the level of knowledge, or technology at
  the time.

3
Ratios

• (Y/Pop) output per capita.
• (N/Pop) the participation rate.
• (Y/N) output per worker.
• (Y/hN) output per hour worked.

4
Production Function Ratios

• Y fhN, K, NR, T
• Y/Pop Y/NL/Pop
• Y/N fh, K/N, NR/N, T
• Y/hN f K/hN, NR/hN, T

5
Output per capita

• Y 10,000 billion / N 134.7 million,
• Equals 75,239 per worker.
• N 134.7 million/Pop 275 million equals an
  employed participation rate of 49. (out of
  total population)
  
• Thus Y/Pop 36,360 Output per Person.

6
Average Productivity (in US)

• N(135 Million) times h (2,000 hours)
• 270 billion hours per year.
• Y/hN 10,000 trillion(Y) / 270 billion (hN)
• 37.00 per hour.

7
What determines

• The size of the Labor Force, N?
• The Participation Rate, N/Pop?
• h, the average hours worked?

8
Real GDP and Employment

• To produce more output, we must use more
  inputs.
  
• In the short run, the quantity of capital and the
  state of technology are fixed.
  
• Then output is a function of the size of the
  labor force.
  
• Y f(hN,K,NR, T)

9
Real GDP and Employment

• The Production Function
• The production function shows how real GDP
  varies as the quantity of labor employed varies,
  other things remaining the same.

10
The Production Function
Production function
10
7
Real GDP (trillions of 1992 dollars per year)
4
0
200
100
300
400
500
Labor (billions of hours per year)
11
Real GDP and Employment

• Any influence on production that increases
  labor productivity shifts the production function
  upward.
  
• Real GDP increases at each level of labor
  hours.

12
An Increase in Labor Productivity
8.0
6.9
PF80
4.6
a
Real GDP (trillions of 1992 dollars per year)
2.0
0
300
175
100
218
Labor (billions of hours per year)
13
Real GDP and Employment

• When we talk about productivity, we usually
  mean labor productivity.
  
• Labor productivity real GDP per hour of labor
• Factors that influence labor productivity
• Physical capital
• Human capital
• Technology

14
The Labor Market

• The labor market determines the quantity of
  labor hours employed.
  
• The labor market
• The demand for labor
• The supply of labor
• Labor market equilibrium

15
The Demand for Labor

• The quantity of labor demanded is the number
  of labor hours hired by all firms in the
  economy.
  
• The demand for labor is the relationship
  between the quantity of labor demanded and the
  real wage rate.

16
The Real Wage

• The money wage rate is the number of dollars
  that an hour of labor earns.
  
• The real wage rate is the quantity of goods
  and services that an hour of labor earns.
  
• The real wage rate is equal to the money wage
  rate divided by the price level multiplied by 100.

17
The Demand for Labor
50
40
30
Marginal product of labor (1992 dollars per hour)
25
20
10
0
150
250
500
200
100
400
300
Labor (billions of hours per year)
18
The Marginal Product of Labor

• The demand for labor is downward sloping because
  the Law of Diminishing Returns.

19
Shifts in the Demand for Labor

• When the marginal product of labor changes, the
  demand for labor changes and the demand curve for
  labor shifts.
  
• An increase in capital and an advance in
  technology that increase productivity shifts the
  production function upward

20
The Supply of Labor

• The quantity of labor supplied is the number of
  labor hours that all the households in the
  economy plan to work depending on the real wage.

21
The Supply of Labor
50
45
40
Marginal product of labor(1992 dollars per hour)
30
25
20
10
0
250
400
150
500
200
100
300
Labor (billions of hours per year)
22
The Supply of Labor

• Hours Per Person
• The rise in the real wage rate has two opposing
  effects
  
• It makes the household want to consume less
  leisure and to work more.
  
• And by increasing the households income, it
  makes the household want to consume more leisure
  and to work fewer hours.

23
The Labor Market Equilibrium
50
The labor market
Real wage rate (1992 dollars per hour)
25
0
250
400
150
500
200
100
300
Labor (billions of hours per year)
24
Potential GDP

• At the labor market equilibrium we say the
  economy is at full employment.
  
• Using the production function, the full
  employment number of workers will produce and
  amount of output we call potential GDP.

25
The Labor Market and Potential GDP
Potential GDP
10
PF
8
7
Real GDP (trillions of 1992 dollars per year)
6
4
2
0
500
200
400
150
250
100
300
Labor (billions of hours per year)
26
The Long-Run Aggregate Supply Curve

• Potential GDP will determine the LAS that will be
  discussed in lecture 11.

27
Changes in Potential GDP

• Potential GDP will increase with increases in h,
  Pop, (N/Pop) and labor productivity, (Y/hN).

28
An Increase in Hours Supplied
50
40
30
Real wage rate (1992 dollars per hour)
25
15
10
0
500
200
100
300
400
Labor (billions of hours per year)
29
An Increase in Potential GDP
10
PF
9
7
Real GDP (trillions of 1992 dollars per year)
6
4
2
0
500
200
100
300
400
Labor (billions of hours per year)
30
An Increase in Productivity
LS
50
Increase in capital and advances in technology
increase the demand
for labor . . .
40
35
Real wage rate (1992 dollars per hour)
30
25
10
0
500
200
100
300
400
220
Labor (billions of hours per year)
31
A Shift in the Production Function
12
10
PF0
8
7
Real GDP (trillions of 1992 dollars per year)
shifts the production function upward and inc
reases potential GDP
6
4
2
0
200
100
300
400
500
220
Labor (billions of hours per year)
32
Full Employment in the UnitedStates 1984 and
1998
The labor market
19
Real wage rate (1992 dollars per hour)
16
0
300
150
100
227
250
185
Labor (billions of hours per year)
33
Full Employment in the UnitedStates 1984 and
1998
U.S. production function in 1984 and 1998
8.0
7.6
6.0
Real GDP (trillions of 1992 dollars per year)
5.10
4.0
2.0
0
300
150
100
227
250
185
Labor (billions of hours per year)
34
Unemployment at Full Employment

• Why is there always some unemployment?
• Job search
• Demographic change
• Unemployment compensation
• Structural change
• Job Rationing
• Efficiency wage
• Minimum wage

35
Job Search Unemployment
50
35
Marginal product of labor (1992 dollars per hour)
25
15
0
500
200
100
300
400
Labor (billions of hours per year)
36
Did you learn?

• The relationship between the quantity of labor
  employed and real GDP?
  
• What determines the demand for labor and the
  supply of labor?
  
• How labor market equilibrium determines
  employment, the real wage, and potential GDP?
  
• How changes in the labor market will change the
  value of potential GDP?