Chapter 3 Flashcards
What is the production function?
Y = A X F(K, N)
Productivity = A
Amount of labour = N
Amount of capital = K
What is the production function?
Slopes upwards
Slop flattens as input rises - diminishing marginal product as input increases
How does the production function relate output and capital?
Marginal product of capital, MPK = change in Y/ change in K
- MPK is always positive
- Diminishing marginal productivity of capital
- MPK declines as K rises
What is the marginal product of labor?
Equal to the slope of production function graph
- MPN is positive
- Diminishing marginal productivity of labor
Demand for labor and investment funds are the same as their marginal productivity factors
What is the graph for the determination of labor demand?
Downwards sloping with real wage on the y axis and labor on the x axis
MPN and labor demand (ND) downwards curve and horizontal line - real wage
What is a supply shock?
Productivity shock
Change in an economy’s production function
Affects the amount of output that can be produced for a given amount of inputs
+ or -
Such as weather, oil prices, regulations, etc.
How is a negative supply shock shown on the graph of production as a function of labor?
Y on y axis and N on x axis
Upwards C curve moves down
What are the effects on parameters of the production function?
If A in Y = A x F(K,N) decreases then there are negative shocks
If A in Y = A x F(K,N) increases then there are positives shocks
What are the assumptions behind the MPN relationship?
Hold capital stock fixed - short-run analysis
Workers are alike
Labor market in competitive
Firms maximize profits
What is the marginal product of labor and labor demand?
Nominal and real wages
MRPN = P x MPN
MRPN = nominal marginal product of labor
P = price level
MPN = real marginal product of labor
W = MRPN is the same condition as w = MPN, since W = p x w and MRPN = P x MPN
How is the demand and supply curves in the labor market predicted?
Demand = MPN
Firms create demand
Supply of labor = individuals create supply
How is labor demand determined?
Change in wage
- begin at equilibrium where w* = MRPN
- rise in wage rate means w > MRPN
- employers have incentive to reduce N
- decline in wage rate means w < MRPN
- employers have incentive to increase N
What is the determination of labor demand?
W on the y axis and N on the x axis
MPN = demand for labor
Horizontal line w
How much labor do firms want to use?
If real wage > marginal product of labor (MPN), profit rises if the number of workers declines
The space between MPN and w0
If w < MPN, profit rises if the number of workers increases
Firms’ profits are highest when w = MPN
What are the factors that shift the labor demand curve?
Change in the supply labor causes a movement along the labor demand curve
- supply shocks shift labor demand curve to the right
Increase in the size of capital stock
- higher capital stock raises MPN so shifts the labor demand curve to the right
What is aggregate labor demand?
Sum of all firms’ labor demand
Supply shocks and size of capital stock shift firms’ aggregate labor demand
Moves ND upwards
How does an increase in productivity and capital stock cause the labor demand curve to shift to the left?
Shifts curve to the right
Beneficial supply shock increases MPN and shifts MPN curve to the right
Higher capital stock increases MPN and shifts MPN to the right
What is the supply of labor?
Determined by individuals
- aggregate supply of labor is the sum of individuals’ labor supply
- labor supply of individuals depends on labor-leisure choice
What is the wealth-leisure trade-off?
Utility depends on consumption and leisure
Needs to compare costs and benefits of working another day
- costs leisure time
+ more consumption
If benefits of working another day exceed costs, work another day
Keep working additional days until benefits equal costs
How does increase in real wage offset the substitution effect?
Higher real wage encourages work since the reward for working is higher
- one-day increase in real wage
- temporary increase has pure substitution effect since the effect on wealth is negligible
How does increase in real wage offset the wealth effect?
Higher real wage increases income for the same amount of work time, so a person can afford more leisure, so will supply less labor
- pure wealth effect is when a person consumes more goods and takes more leisure (winning the lottery)
How does the substitution and wealth effect take place together?
Higher income - substitution effect toward more work
Higher income means less work - wealth effect toward less work
Longer the increased income, the stronger the wealth effect
Substitution effect of an increase in real wage dominates the wealth effect
How does an increase in real wage affect the labor supply curve?
Raise quantity of labor supplied
Curve relates the quantity of labor supplied to real wage
Upwards slope since higher wage encourages more people to work
What are factors that shift the labor supply curve?
Wealth - higher wealth reduces labor supply so curve shifts to the left
Expected future real wage - higher expected future real wage is like an increase in wealth so curve sifts to the left
What are factors that increase the labor supply?
Decrease in wealth
Decrease in expected future real wage
Increase in working-age population
Increase in labor force participation
What is the labor market equilibrium?
Labour supply (NS) crosses labor demand (ND)
w on y axis
labor on x axis
What does the classical model of labor market state?
Real wage adjusts quickly and on its own
What is full-employment output?
Full-employment output = potential output = level of output when labor market is in equilibrium
Y = AF(K,N)
What is the effect of a temporary adverse shock to production on the labor market?
ND shifts to the left, real wage falls and employment falls
How long are people unemployed for?
Short duration
Unemployment spell = time an individual is continuously unemployed
What is frictional unemployment?
Search activity of firms and workers due to heterogeneity
What is NRU?
When output and employment are at full-employment levels
- frictional + structural
Cyclical: difference between actual unemployment rate and NRU
What are alternative measures of the unemployment rate?
- Unemployed 15+ weeks
- Count job losers so it does not count people who quit
- Official rate
- 3 + discouraged workers
- 3 + 4 + marginally attached workers (want a job/looked for work in past year)
- 3 + 4 + 5 + part-time employment
