Chapter 3 Flashcards
Factors of production are classified into
- Capital
- Labour
- Others
Others include Raw material, land, energy
The amount of output produced depends on the quantities of
Capital and labor and their productivity
Productivity depends on
technology and management
Production Function is
A mathematical expression relating the amount of output
produced to quantities of capital and labor utilized, given current state of technology
The production Function
State the Production Function Formula
Y = A F (K, N)
‘Y’ is real output and ‘A’ is overall total factor productivity
Cobb-Douglas
Production Function
Y = A (K^α) (N^(1-α))
This production function applies to
Y = A F (K, N)
Both an economy as a
whole and individual firms
This production function applies to
Y = A F (K, N)
Both an economy as a
whole and individual firms
Increase in productivity (A) happens from
Improvements in technology or any other change in the economy that allows capital and labor to be utilized more effectively
The Shape of the production function is
Upward sloping but with decreasing slope as increasing the variable on the x-axis
Why does the slope of the production function becomes flatter as input rises
Diminishing marginal
product as input increases
Marginal Product of Capital is
The increase in output produced that results from one-unit increase in the capital stock.
MPK =
Change in Y/ Change in K
The slope of production function graph (Y vs. K) is the same as
MPK
Two main properties of production functions:
- MPK/MPN is always positive (more K increases Y or more N increases Y)
- Diminishing marginal productivity of capital/Labour (MPK declines as K rises or MPN declines as N rises)
Marginal Product of Labor is
The increase in output produced that results from one-unit increase in labor
MPN =
Change in Y/ Change in N
The slope of production function graph (Y vs. N) is the same as
MPN
Supply shocks involves a change
Productiivity shocks
In an economy’s production function
Supply shocks affect the
output that can be
produced for a given amount of inputs
Supply shocks incorporates changes in
The supply of factors of production other than capital and labor or changes that affect technologies or production methods used
Positive supply shocks can happen from
- Inventions
- Innovation in Management techniques
- Government regulations
- Oil prices
Positive supply shock raises
Output for a given amount of K and N
Upward Shift
Negative supply shock can happen because of
Unfavorable Weather, Oil prices
Negative supply shock leads to
a Lower output for a
given amount of K
and N
Downward shift
To be able to answer the following question:
“How much labor do firms want to use?”, a set of assumptions must set
List these assumptions
- Hold capital stock fixed.
- Workers are all alike
- Labor market is competitive.
- Firms demand the amount of labor that maximizes profits.
How firms demand the amount of labor that maximizes profits
It compares the cost of additional labor (wage) with its additional benefit (additional output produced)
Marginal Product of Labor (MPN) measure
The benefit of employing an additional worker in terms of extra output produced
Marginal Revenue Product of Labor (MRPN) measures
The benefit of employing an additional worker in terms of extra
revenue produced
MRPN =
P multiplied by MPN
To Maximize Profit the firm will either
The profit-maximizing point for a Firm
- Set the nominal wage equal to the marginal revenue product of labor
- Set the real wage equal to the marginal product of labor
W = MRPN where the ‘W’ here represent
Nominal Wage
w = MPN where the ‘w’ here represent
Real Wage=W/P
Increase employment if for an additional worker
Elaborate both in real and Nominal terms
MPN>w (Real terms)
P x MPN > W (Nominal terms)
Decrease Employment if for the last worker employed
Elaborate both in real and nominal terms
MPN < w (Real terms)
P x MPN < W (Nominal terms)
MPN curve is the same as
Labor demand curve
Labour demand curve shows
The quantity demanded of labor at any real wage
Any point on the labor demand curve is a
Profit maximising point
How changes in real wages affect the labour demand curve
Movements along the curve
An increase in productivity will cause
Factor that shifts the aggregate labour curve
The labour demand curve shifts to the Right
An increase in Capital stock causes
Factor that shifts the aggregate labour curve
The labour demand curve shifts to the Right
The Reason behind shifts of the aggregate labour demand curve when productivity increases
Beneficial supply shock increases MPN and shifts MPN curve up and to the right
The Reason behind shifts of the aggregate labour demand curve when Capital stock increases
Higher capital stock increases MPN and shifts MPN curve up and to the right
Aggregate Labor Demand is the
sum of the labor demands of all the firms in an economy.
How does Supply shocks and change in the capital stock affect the aggregate labor demand
Causes a shift
Aggregate labour demand curve looks exactly like
Labor demand for an individual firm
The supply of labor is determined by
Households
To determine how much to work, individual compare
Benefit (income earned) with cost (forgone leisure)
Leisure refers to
all off-the-job activities
E.g. Eating, Sleeping etc.
What should individuals do to maximize utility
Individuals should work until the utility received from additional income equals the loss of utility associated with the missed leisure
Real Wage is the
Amount of real income the worker receives in exchange for giving up a unit of leisure for work
Two effects arise when Real wage increase
- Substitution effect
- Income effect
Substitution effect is
The tendancy to supply more labour due to higher wages
One day rise in real wage
Income Effect is
Tendency to
supply less labor due to becoming wealthier
E.g. Winning a lottery or an increase in expected future income
Which effect is related to an increase in labour supply
Substitution Effect
Which effect is related to a decrease in labour supply
Income effect
What are some of the factors that can affect the Income and Substitution effect?
- Length of time the increase is expected to last.
- Intial level of income
- Person’s family situation
- Income tax rate
Which effect is more likely to persue if there is a temporary increase in Wages
Substitution effect
Which effect is more likely to persue if there is a high income tax rate
Income effect
The labor supply curve Relates the amount of labor supplied to
The current real wage rate (expected future real wage)
holding other factors constant
Why Labor supply curve is upward sloping
Because as current wage rate inc. the supply of labor inc.
What factors causes the labor supply curve to shift to the left
- Inc. in expected income
- Inc. in wealth
Aggregate labor supply curve
It is the total amount of labor supplied by everyone in the economy
An increase in the current economy-wide real wages would cause a raise or reduction in the quantity of labor supplied ?
Raises quantity of labor since an inc. in w could encourage people out of the labour force to seek work
Factors that causes a shift in the labor supply curve
- Wealth
- Expected future real wage
- Working-Age population
- Participation rate
Factors that causes the labor supply curve to shift to the left
- Wealth
- Expected future wage
Factor that causes the supply curve to shift to the right
- Working age population
- Participation rate
Why does an inc. in wealth causes the labor supply curve to shift to the left
Increase in wealth increases amount of leisure workers can afford
How is equilibrium determined in the labor market?
When aggregate quantity of labor demanded equals aggregate quantity supplied
When sketching the labor market equilibrium, if there was temporary adverse supply shock what happens to the new equilibrium
Demand curve for labor will shift to the left leading to
* Lower real wage
* Employment falls
Permenant supply shocks causes a shift in
in both demand and supply
What is the main issue that could have caused the following:
Lower expected future wage consequently a rightward shift in labor supply curve
A permenant supply shock
Full employment output is the level of output denotes
- firms in the economy supply when wages and prices have fully adjusted
- it is the level of output supplied when aggregate employment equals its full-employment level
(Y-bar) = A.F(K, N-bar)
What would affect Y-bar
Any change in N-bar or A
How would adverse supply shock that reduces MPN affect Y-bar
- Reduces A hence lowering ouput directly
- Reduces demand for labor and hence reduces N-bar that reduces Y-bar
Adverse supply shock lowers labor demand, reducing employment and real wage, as well as reducing
Output
Participation rate is
Fraction of adult population (working age population) in the labor force.
= Labor Force ÷ Adult Population
Discouraged workers are
Unemployed people that decided to leave the labor force
not working in activities outside the labor market
Unemployment spell
The period of time that an individual is continously unemployed
Duration of unemployment spell
The length of time that an unemployment spell lasts
Complete unemployment spell
It begins when the person become unemployed till he is no longer unemployed
Incomplete or ongoing spells
Are spells that have not ended
Mean duration of unemployment is
The average length of incomplete spells
Duration of unemployment spells increase during
Recession
and decrease during expansions
Even at full employment, Unemployment rate is not zero
- Frictional Unemployment
- Structural unemployment
Frictional unemployment happens due to
Matching process
Frictional unemployment happens due to
Matching process
Structural unemployment is
Long-term chronic unemployment
Structural unemployment happens due to
Low skilled labor or relocation of labor across industries
Natual rate of unemployment prevails when
Output and employment are at full level
Cyclical unemployment is
The difference between actual unemployment rate (u) and natural unemployment rate (u-bar)
If cyclical unemployment is positive then
What is happening in terms of output and employment
Output and employment are below
their full employment levels
If cyclical unemployment is negative then
Output and employment exceeds their full employment levels
Okun’s law is considered a ________ more than a law
Rule of Thumb
Okun’s law show the relation between
output (relative to potential
output) and cyclical unemployment
i.e. how changes in unemployment affects output
State the equation of okun’s law
(Y-bar minus Y)/ Y-bar = 2(u-(u-bar))
According to Okun’s law, for each percentage point increase in unemployment, the gap
between full employment output and actual level of output increases by
2% point
According to Okun’s law, the percentage gap between potential and actual output equals 2 times
Cyclical unemployment
