Topic 3 Flashcards
What are the factors of production?
Capital (K)
Labour (N)
Others (raw materials, land, energy etc)
What does the productivity of factors of production depend on?
Technology and management
What is the equation of the production function?
π = π΄πΉ(πΎ, π)
What is parameter A in the productivity function?
Parameter π΄ represents the total factor productivity β a measure of the effectiveness with which capital and labour are used
What is the equation of the Cobb-Douglas production function?
π = π΄πΎ^πΌ x π^1βπΌ
Where πΌ β 0,1 (i.e., 0 < πΌ < 1)
What is the Cobb-Douglas production function characterised by?
This production function is characterised by Constant Returns to Scale (CRS)
What happens when you multiply the Cobb-Douglas production by lamda?
Total output is multiplied by lamda
What are the main two properties of the production function?
Slopes upward: more of any input produces more output
Slope becomes flatter as input rises: diminishing marginal product as input increases
What is on the axis of the production function?
Y-axis = Output, Y
X-axis= Capital, K
Consider π = π΄πΉ(πΎ, π), how do you calculate the marginal product of capital (MPK)? (2)
πππΎ =Ξπ/ΞK
πππΎ = π΄ ππΉ / πK
What is the MPK equal to?
The slope of the production function
How do you represent the MPK as a function?
MPK(.) where the dot is in the middle and it represents an independent variable
What are the assumptions of MPK? (2)
πππΎ is always positive
πππΎ declines as πΎ increases (diminishing marginal productivity of capital)- upwards concave
Consider π = π΄πΉ(πΎ, π), what is the marginal product of labour (MPL)? (2)
πππ =Ξπ / ΞN
πππ = π΄ ππΉ / πN
What is the MPN equal to?
πππ is equal to the slope of the production function graph
What are the assumptions of MPN? (2)
πππ is always positive
πππ declines as π increases (diminishing marginal productivity of labour)
How do you calculate MPK using the Cobb-Douglas function?
Consider the production function π = π΄πΎ^πΌ x π^(1βa).
πππΎ =ππ (β) / ππΎ =
πΌπ΄πΎ^ (πΌβ1) x π(^1βπΌ)
= πΌπ΄ (π / πΎ)^(1βπΌ)
MPK = πΌπ΄ (π / πΎ)^(1βπΌ), what happens as K rises?
What happens when A rises?
What type of function is MPK in terms of N?
As K rises, MPK falls.
As A increases, MPK increases.
MPK is an increasing function of N.
How do you calculate MPN using the Cobb-Douglas function?
Consider the production function π = π΄πΎ^πΌ x π^(1βa).
ππN =ππ (β) / πN =
(1 - πΌ)A(K / N)^πΌ
MPN= (1 - πΌ)A(K / N)^πΌ, what happens as N rises?
What happens as K rises?
What happens as A rises?
As N rises, MPN falls.
As K rises and π²/π΅ is higher, MPN also rises.
As A rises, MPN increases.
What is a supply shock?
A change in an economyβs production function
What do supply shocks affect?
Supply shocks affect the amount of output that can be produced for given quantities of capital and labour
What is a positive supply shock?
The economy produces more output (Y) for given quantities of capital (K) and labour (N).
What is a negative supply shock?
The economy produces less output (Y) for given quantities of capital (K) and labour (N)
What are some examples of supply shocks?
Look at slides, or textbook.
How do we model supply shocks?
Through changes in the value of the productivity parameter A
What will a positive and negative supply shock do to parameter A?
A positive supply shock will always increase the value of productive parameter A
A negative supply shock will mean a decrease in the value of A
What do we assume that a positive supply shock will do to both MPK and MPN?
A positive supply shock will increase the values of both MPK and MPN
What do we assume that a negative supply shock will do to both MPK and MPN?
A negative supply shock will decrease the values of both MPK and MPN
How does the slope of the production function change from a positive supply shock?
The slope of the production function increases at each level of output
How does the slope of the production function change for a negative supply shock?
The slope of the production function decreases at each level of input
What are the assumptions of the labour markets on a micro level? (4)
Hold capital stock fixed (short-run & medium-run analysis)*
Workers and firms are alike
Labor market is competitive (Classical approach)
Firms maximize profits
How do we sometimes represent the production function in the SR, when capital stock is fixed?
The K has a bar on top
What is the short-run time horizon?
The time period during which aggregate output and employment can change but before prices and wages respond to the changes in economy-wide output and employment levels
What does not adjust to macroeconomic conditions and policies in the short-run?
The economyβs price level (π) and (nominal or real) wage rate
What is meant by real wage rigidity?
The idea that the real wage rate moves βtoo littleβ in response to conditions in the aggregate labour market
What is price stickiness?
The tendency of prices to respond only slowly to
changes in the economy
What is the medium-run time horizon?
The time period during which prices and wages can respond to changes in aggregate output and employment
What do we continue to assume in the medium-run?
We continue to assume (as for the short-run) that the economyβs capital stock (πΎ) and labour force
(ππΉ) are fixed
What do we not investigate in the MR?
We do not investigate changes in the population growth rate or allow for migration- belongs in the LR.
In the MR, what can we investigate?
The consequences of changes in technology- exogenous
To investigate the causes of productivity growth (endogenous) and why it might change, what time horizon do we need analyse?
The LR
In LR analysis, what do we allow for the analysis of?
We allow for growth in the population, in the physical capital stock (πΎ), human capital stock (skills of workers), and improvements in technology
What is a firmβs profit function?
Ξ = π Γ π (β) β π Γ N
p= price
W= wage
What is the optimality condition?
πΞ / ππ = π Γ [ππ (β) / ππ] β π = 0
At a given π level, the quantity of labour demanded is given by what?
p x MPN(.) = π Γ ππ / ππ = W
π Γ ππ (β) / ππ = p x MPN(.) , what does this equation equal?
The marginal revenue product of labour (MRPN)
According to the optimality condition, what is the MPN(β) equal to?
Real wage rate
Suppose that at a given π level, ππ ππ (β) > π or πππ (β) > π€, what is the optimal course of action?
To increase the quantity of labour demanded =
Suppose that at a given π level, ππ ππ (β) < π or πππ (β) < w, what is the optimal course of action?
To reduce the quantity of labour demanded
What does the labour demand curve show the relationship of?
Shows the relationship between the real wage rate and quantity of labour demanded
What is the labour demand curve the same as, and why?
It is the same as the πππ curve, since π€ = πππ at equilibrium
Why is the labour demand curve downward sloping?
Firms want to hire less labor, the higher the real wage
In real terms, when should a firm increase or decrease employment?
Increase when πππ > w.
Decrease when πππ < w
In nominal terms, when should a firm increase or decrease employment?
Increase when π Γ πππ > W
Decrease when π Γ πππ < W
On a diagram, what do we denote the beginning equilibrium where MPN=w?
NDo
What happens when there is a rise in real wage rate?
Means that at ππ·o, we now have: πππ < w.
Amount of labour demanded falls.
How is a rise in MPN, all else equal, shown on a diagram?
Shift outward of labour demand curve (ND)
What does a rise in MPN mean in terms of a diagram ?
Means that at NDo, MPN > w.
So, the amount of labour demanded rises.
What does a beneficial supply shock do to MPN?
A beneficial supply shock raises MPN, so it shifts the labor demand curve to the right; the opposite for an adverse supply shock
Why does the size of capital stock shift the labour demand curve?
A higher capital stock raises MPN, so shifts the labor demand curve to the right; the opposite for a lower capital stock
What does a change in the nominal or real wage cause on a diagram in terms of the demand curve?
Causes a movement along the labour demand curve
What is the aggregate labour demand (ND)?
The sum of all firmsβ labour demand
What factors shift the aggregate labour demand curve? (2)
Productivity
Capital stock
How can we express the aggregate labour demand function?
ππ· = ππ· (π€; π΄,πΎ,Ξ©)
w = real wage rate
A= supply shocks
K= size of economyβs capital stock
Ξ©= composite variable (every other variable that could have an effect)
What denotes real wage and nominal wage?
Real wage = w
Nominal wage = W
How do you measure the real wage?
w = W / Price of output
What is individual labour supply derived from?
Individual labour supply is derived from the optimizing behavior of households as they
allocate their time between work and leisure to maximize their utility
What is the individual utility function?
U = U(c,L)
c= consumption
L= leisure
What do we assume for the marginal utilities of consumption and leisure?
We assume that ππ (β)/ ππ > 0 and
ππ (β) /ππΏ > 0
What is the constraint for an individual when deciding how to offer their labour?
Time constraint (T) (24 hours)
π€πππ π‘πππ + ππππ π’ππ π‘πππ = T
What is the income leisure tarde off?
Compare the costs and benefits of working another day
How should we decide how much labour to offer?
If the benefit of working another day exceeds the cost, work another day. Keep increasing labour time until benefits equal costs.
What are the costs and benefits of the income-leisure trade off?
Cost: Loss of leisure
Benefit: More consumption, since labour income is higher
What is the substitution effect?
Higher real wage encourages work, since the opportunity cost of leisure is higher
How do you know the opportunity cost of leisure?
It is the real wage rate
How does an increase in the real wage create the substitution effect?
ππΈ: β π€ β β ππππ π’ππ β β π€πππ π‘ππe
What is the income effect?
Higher real wage increases income for the same amount of work time, so the person can afford more leisure. Thus, she will supply less labor
What type of good is leisure?
A normal good
How does an increase in the real wage create the income effect?
πΌπΈ: β π€ β β ππππ π’ππ β β π€πππ π‘ππe
What is a pure substitution effect?
A one-day rise in the (current) real wage. The effect on the
(present value of expected future) wealth or lifetime income is negligible
The bigger the change in lifetime resources theβ¦.
Stronger the income effect
What are lifetime resources?
Wealth (π, defined as assets β liabilities) + expected future wealth (π^e) + lifetime labour income (determined by the current real wage rate, π€ and the expected future real
wage rate, (π€^π)
What would a temporary real wage increase lead to?
A fall in leisure and an increase in work time- substitution effect dominates the income effect
What is the pure income effect?
An increase in wealth
Why doesnβt and increase in wealth have a substitution effect?
Because it doesnβt affect the price of
leisure
How does an income in wealth create the pure income effect?
But winning the lottery makes a person wealthier, so a person will both consume more goods and take more leisure; this is a pure income effect
Other than wealth, what can cause a pure income effect?
An increase in the expected future real wage
Why does an increase in the expected future real wage not cause a substitution effect?
Because the current wage does not change, there is no effect on the price of leisure and there is no substitution effect on current labour supply
For a long-term increase in real wage, what effect gets stronger with time?
The income effect
What will a long-term increase in real wage cause in the labour supply compared to a temporary change?
Labor supply will increase by less (or decrease by more if income effect dominates) compared to the case of a temporary increase in the real wage
What is the overall result of an increase in the temporary real wage?
Labor supply increases with a temporary rise in the real wage
(substitution effect dominates)
What is the overall result of an increase in the permenant real wage?
Labor supply falls with a permanent increase in the real wage (income effect dominates).
Why does the labour supply curve slope upwards?
Because a higher current real wage rate (holding constant the expected future real wage) encourages people to work more (substitution effect dominates)
What denotes the labour supple curve?
NS
How does an increase in the expected real wage rate effect the labour supply curve?
Shifts NS to the left
What two factors shift the labour supply curve?
Wealth
Expected future real wage
How does wealth shift NS?
Higher wealth reduces labour supply
When does the aggregate labour supply rise?
When the current real wage rises (movement along the labour supply curve)
What effect causes people to enter the labour force?
Substitution effect
What factors increase aggregate labour supply? (4)
Decrease in wealth
Decrease in expected future real wage rate
Increase in working-age population (higher birth rate, immigration)
Increase in labour-force participation rate (increased female labour participation, elimination of mandatory retirement)
What is the participation rate?
% of adult population in the labour force
How do you denote labour market equilibrium?
the real wage π€ bar and employment π bar
For Classicists, what happens when there is a temporary deviation from equilibrium?
Assumed to be eliminated by a movement in real wages. The real wage rate adjusts quite quickly to bring the market to equilibrium
What is reached at the labour market equilibrium?
Full level of employment (Nbar)
What type of unemployment is not present in a competitive labour market (Classical)?
Involuntary
How do you denote the labour force?
NF
What does labour market equilibrium look like on a diagram?
Look at slides and watch back lecture
What is the function that shows full employment level of output (πbar)?
Ybar = AF(K, Nbar)
Nbar= full employment level
What type of unemployment is shown by excess supply (Classical) ?
Involuntary
What is the market said to be when equilibrium is reached?
Cleared
How does a temporary adverse supply shock that lowers the MPN affect A?
Lowers output directly by reducing the amount of output that can be produced with any fixed amounts of capital and labour. This direct effect can be thought of as a reduction in π΄.h
How does a temporary adverse supply shock that lowers the MPN affect the ND?
Reduces the demand for labour, ππ·, and thus lowers the full-employment level of employment
How does a temporary adverse supply shock that lowers the MPN affect the NS?
We assume that a temporary supply shock does not cause a shift of the labour supply
curve (πS)
Define the labour force.
Those who are able to have a job and want to have one
What is the adult population?
Over 16
π΄ππ’ππ‘ ππππ’πππ‘πππ = πΏππππ’π πππππ + πππ‘ ππ πΏππππ’π ππππe
Who are discouraged workers?
People who have become so discouraged by lack of success at
finding a job that they stop searching β Not in the labour force
How do you measure the unemployment rate (u)?
No. of unemployed / Labour force
(NF - E) / NF
U / NF
How do you measure the participation rate?
Labour force / Adult population
(E + U) / Pop
NF / Pop
How do you measure the employment ratio?
Employed / Adult population
(NF - U) / Pop
E / Pop
What type of unemployment always exist?
What do they prevent?
Frictional and structural unemployment
Prevent the unemployment rate from ever reaching zero- still present at equilibrium
What is frictional unemployment? (2)
The unemployment that arises as individuals search for suitable jobs and firms search for suitable workers.
Joblessness experienced by people who are entering the labour force for the first time or after an absence
Why is there always frictional unemployment?
Because jobs are continually being created and destroyed and workers continually enter and exit the labour force
Is frictional unemployment present in the short-term of the long-term?
Usually the short-term
What is structural unemployment?
Unemployment arising from mismatches (a) between workersβ skills and employersβ requirements, or (b) between workersβ locations and employersβ locations
Why does structural unemployment arise?
Arises from structural changes in the economy: when old, dying industries are replaced with new ones that require different skills and are located in different areas of the country
Is structural unemployment generally long term of short term?
Long term
Who are the chronically unemployed (classified under structural unemployment)?
Workers who are unemployed a large part of the time. Usually, the lack of skills prevents them from finding long-term employment
What is cyclical unemployment?
The unemployment that is caused by the business cycle
What is cyclical unemployment a problem for?
Deciding on macroeconomic policy
When do macroeconomists say that full employment has been reached?
When cyclical unemployment is reduced to zero, even though substantial amounts of frictional & structural unemployment may remain
What is the natural rate of unemployment (u bar)?
The unemployment rate when output and employment are at full-employment levels
What is the natural rate of unemployment equal to?
The frictional and structural unemployment
What percentage of the unemployment rate is said to be due to frictional and structural unemployment?
4.5-5%
What is said to be present if the unemployment rate is above 5%?
Cyclical unemployment
How do you calculate cyclical unemployment?
Difference between the actual and the natural rate of unemployment:
ππ = π β πn
