Macroeconomic Theory

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Macroeconomic Theory

• Aggregate Supply
• The Labor Market
• Full Employment

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The Macroeconomic Model

• Recall the Income-Expenditures Identity
• Y C I G NX
• Aggregate Supply Aggregate Demand
• Aggregate Supply - What determines the
  productivity capacity of the economy?

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Aggregate Supply

• A production function shows how much output can
  be produced with a given quantity of inputs
  (factors of production).
• Aggregate Production Function
• Y AF(K,N)
• Y GDP
• K Capital
• N Labor
• A productivity/technological factor/supply
  shock.

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• Marginal Product of Capital (MPK)
• Marginal Product of Labor (MPN)
• Two Fundamental properties of production
  functions
• (1) Increasing in K and N
• (2) Diminishing Marginal Returns

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• Supply shocks are factors which change the amount
  of output which can be produced by a given
  combination of capital and labor.
• Two Effects of Supply Shocks
• (i) Changes Y produced with given amount of K
  and N (Shifts production function)
• (ii) Changes MPN (changes slope of production
  function)

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• Application Cobb-Douglas Production Function
• Y AF(K,N) AK0.3N0.7
• Labor Income/GDP 70
• Capital Income/GDP 30

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Table 3.1 The Production Function of the United
States, 19802004
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Figure 3.1 The U.S. production function
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Figure 3.3 The production function relating
output and labor
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The Labor Market

• Labor Demand
• Given a fixed amount of capital, how much labor
  will firms employ and how much output will the
  economy produce?
• Marginal Revenue Product of Labor (MRPN) is the
  revenue a firm obtains from employing an
  additional worker
• (P)(MPN)

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• Firms employ workers to maximize profits when
• MRPN W
• or
• MPN W/P w
• The aggregate labor demand (ND) curve indicates
  how much labor profit maximizing firms will
  employ at a given real wage rate. Identical to
  the MPN curve.
• Factors which shift ND curve An increase in
• (i) Supply Shocks (A) ? right
• (ii) Changes in capital stock (K) ? right

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• Labor Supply
• How much labor are workers willing to supply at a
  given real wage w?
• Labor-Leisure trade-off
• Increase in real wage w
• Temporary gt increase labor supply
• (substitution effect)
• Permanent gt decrease labor supply
• (income/wealth effect)

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The workweek and real GDP per person in 36
countries (1980s and 90s)
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Figure 4.13 Average Weekly Hours in the United
States, 19802003
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Figure 4.12 Real Wage in the United States,
19802003
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• The aggregate labor supply (NS) curve indicates
  how much labor workers are willing to supply at
  any given current real wage rate (w).
• Upward sloping inc in w gt inc in NS
• Factors that shift NS Curve An increase in
• (i) Expected Future Real Wages ? Left

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• (ii) Wealth ? Left
• (iii) Population/ Labor Force Participation ?
  Right

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• Labor Market Equilibrium
• Equilibrium gt labor demand labor supply
• ND NS
• gt Equilibrium and
• Examples
• Real Wage Growth
• Wage Inequality
• Wages in Developing Countries

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Wage Inequality 1969-1996
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• Full employment level of output is the amount of
  output produced when labor market is in
  equilibrium
• Examples (i) A Positive Supply Shock
• (ii) Increase in Labor Force Participation