Productivity Shocks Flashcards
What is the production function and the productivity shock negatives and positives.
Definition: The production function shows how inputs (capital and labor) combine to produce output. Formula: Y = zF(K, N), where z is productivity, K is capital, and N is labor.
• Impact of Productivity Shocks:
1. Beneficial Productivity Shocks:
• Higher Output: More is produced with the same inputs.
• Increased Labor Demand: Higher MPN encourages firms to hire more workers.
• Higher Wages: Firms can pay workers more because productivity improves.
• Economic Growth: Leads to sustained increases in potential output.
2. Adverse Productivity Shocks:
• Lower Output: Efficiency drops, reducing output with the same inputs.
• Decreased Labor Demand: Lower MPN discourages hiring and can increase unemployment.
• Lower Wages: Workers’ output is less valuable, reducing pay.
• Economic Contraction: Persistent shocks harm potential output and growth.
• Diagram: A beneficial shock shifts the production function upward, while a negative shock shifts it downward.
What is the Marginal Product of Labor (MPN)?
Definition: The MPN is the additional output produced by hiring one more worker, holding capital constant.
• Impact of Productivity Shocks:
1. Beneficial Productivity Shocks:
• Higher MPN: Workers become more productive, increasing their contribution to output.
• Increased Labor Demand: Firms hire more workers as MPN rises, reducing unemployment.
• Higher Wages: Firms can pay workers more because their output value increases.
2. Adverse Productivity Shocks:
• Lower MPN: Workers become less productive, reducing their output contribution.
• Decreased Labor Demand: Firms hire fewer workers or lay off staff, increasing unemployment.
• Lower Wages: Workers’ reduced productivity leads to lower real wages.
• Diagram: A positive shock shifts the MPN curve upward, while a negative shock shifts it downward.
How do firms decide on profit-maximizing labor input?
Firms hire workers until the real wage equals the MPN.
With a higher MPN, firms hire more workers at the same wage, increasing labor demand and shifting the labor demand curve right.
What is the impact of a temporary productivity shock on the LM curve?
A temporary productivity shock increases output and lowers prices, which increases the real money supply.
The LM curve shifts right because lower prices reduce interest rates, stimulating more output.
Definition: The LM curve shows combinations of real interest rates (r) and output (Y) where the money market is in equilibrium (M/P = L(Y, r)).
Negative (Adverse) Productivity Shock:
Short-Run Effect: Decreases output (Y) and raises the price level (P) due to inflation
Real money supply (M/P) decreases because P increases whilst nominal money supply remains constant. Less real money so interest rates need to increase to restore equilibrium. - discourages borrowing and spending reducing output.
LM Curve Shifts Left: Higher prices reduce the real money supply (M/P), increasing interest rates at every output level.
Negative shock: LM curve shifts left.
What happens during a permanent negative productivity shock?
A permanent negative productivity shock decreases MPN and labor demand, leading to lower real wages.
Lower productivity reduces the value of each worker’s contribution, prompting firms to reduce wages and hiring, shifting the labor demand curve left.
Impact on Real Wages: A permanent negative productivity shock decreases MPN and labor demand, leading to lower real wages.
• Reason: Lower productivity reduces the value of each worker’s contribution, so firms reduce wages and hiring.
• Diagram: Labor demand curve shifts left.
What graph is output and labour
R shaped curve beginning from almost bottom left
2 R and the shift
Labour always on bottom
What graph is MPN and labour
2 L shaped curves almost touching axis
What graph is MPN and labur input
2 L shaped curves with real wage line going straight through and the new lines drawn go left
