Week 4

Question 1

The 2 problems of unemployment

Answer 1

The problem of unemployment is usually seen as two separate problems:
The long-run problem, and
the short-run problem

The long-run problem focuses on reducing the natural rate of unemployment

The short-run problem focuses on reducing the cyclical rate of unemployment

Question 2

Unemployment and the ABS

Answer 2

Unemployment is measured by the Australian Bureau of Statistics (ABS).
The ABS surveys 0.5% of Australian households chosen randomly. The survey is known as the Labour Force Survey.
Estimates of unemployment are derived from this survey

Question 3

The 3 categories of employment and the ABS

Answer 3

Based on the answers to the survey questions, the ABS places each adult into one of three categories:
employed
unemployed
not in the labour force

The ABS considers a person an adult if he or she is aged 15 or older.

A person is considered employed if he or she has spent 1 hour of the previous week working at a paid job or family business.

Question 4

Labour force

Answer 4

The labour force is the total number of workers, i.e. the sum of the employed and the unemployed.
A person who is neither employed nor unemployed is not in the labour force
Give examples

Question 5

The unemployment rate

Answer 5

The unemployment rate is calculated as the percentage of the labour force that is unemployed.

unemployment rate = number unemployed/ labour force

multiplied by 100

Question 6

Labour-force Participation

Answer 6

The labour-force participation rate is calculated by dividing the labour force (employed + unemployed) by the adult population (15 year plus)

Question 7

Is unemployment measured correctly?

Answer 7

Discouraged workers &:

Other people may claim to be unemployed in order to receive financial assistance, even though they aren’t truly looking for work.
Is this an issue in Australia?
Underemployed: who are they?

Question 8

Discouraged workers

Answer 8

Discouraged workers, people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics
Where do they show up then?
What is the effect on the unemployment rate?

Question 9

How long are the unemployed without work?

Answer 9

Most spells of unemployment are short.
Most unemployment observed at any given time is long-term.
Most of the economy’s unemployment problem is attributable to relatively few workers who are jobless for long periods of time.
A little numerical demonstration: 14 people, out of which only 2 long-term unemployed (1 year each) and 12 short-term (1 month each)

Question 10

Why Are There Always Some People Unemployed?

Answer 10

In an ideal labor market, wages would adjust to balance the supply and demand for labor, ensuring that all workers are fully employed.

There are two main types of natural unemployment: structural and frictional

Question 11

Frictional unemployment

Answer 11

Frictional unemployment refers to the unemployment that results from the time that it takes to match workers with jobs. Search for the jobs that are best suit their tastes and skills. Inevitable because the econocmy is always changing.

Question 12

Job search

Answer 12

the process by which workers find appropriate jobs given their tastes and skills.
results from the fact that it takes time for qualified individuals to be matched with appropriate jobs
Search unemployment is inevitable because the economy is always changing.
It takes time for workers to search for and find jobs in new sectors.

Question 13

Structural unemployment

Answer 13

Mismatch between the skills required and offered

Question 14

‘classical unemployment’ occurs due to

Answer 14

Minimum-wage laws.
Unions.
Efficiency wages.

Question 15

minimum wages

Answer 15

When the minimum wage is set above the level that balances supply and demand, it creates unemployment.
The national minimum wage is currently $18.29 per hour or $694.90 per 38 hour week (before tax).

Question 16

Minimim wage graph

Answer 16

Photo in favourites on phone 13/8/18

Question 17

Unions

Answer 17

A union is a worker association that bargains with employers over wages and working conditions.
In the 1970s and 1980s, when unions were at their peak, more than half of the Australian workforce was unionized.
A union is a type of cartel attempting to exert its market power.

Question 18

The theory of efficiency wages

Answer 18

Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity.
The theory of efficiency wages states that firms operate more efficiently if wages are above the equilibrium level.
The Ford example

Question 19

Henry Ford’s experiment

Answer 19

Henry Ford introduced the assembly line technique in auto production, thereby ushering in a productivity revolution
In 1914, Ford began paying his workers $5 per day, which was far above the norm
Turnover and absenteeism fell.
Productivity rose so much that Ford’s costs fell
Henry Ford himself called the $5-a-day wage “one of the finest cost-cutting moves we ever made”

Question 20

THE THEORY OF EFFICIENCY WAGES

A firm may prefer higher-than-equilibrium wages for the following reasons:

Answer 20

Worker health
Worker turnover
Worker effort
Worker quality

Question 21

Worker health

Answer 21

: Better paid workers eat a better diet and thus are more productive.

Question 22

Worker turnover

Answer 22

A higher paid worker is less likely to look for another job.

Question 23

Worker effort

Answer 23

Higher wages motivate workers to put forward their best effort.

Question 24

Worker quality

Answer 24

Higher wages attract a better pool of workers to apply for jobs.

Question 25

Asymmetric Information

Answer 25

In many transactions, one individual has better information than the other.

Adverse selection
Moral hazard

Question 26

Adverse selection

Answer 26

Adverse selection occurs when one person knows more about the attributes of a good than another and, as a result, the uninformed person runs the risk of being sold a good of low quality.
Unknown type
Examples
Good/bad quality worker
Screening and signalling (education)

Question 27

Moral hazard

Answer 27

Moral hazard occurs when one person (the agent) is performing some task for another person (the principal). Because the principal cannot perfectly monitor the agent’s behaviour, the agent tends to undertake less effort than the principle considers desirable.

Unknown action
Examples
Will work hard vs be lazy 
Can you think of an incentive contract?
Unemployment benefits?

Question 28

Production and Growth

Answer 28

A country’s standard of living depends on its ability to produce goods and services.
Within a country there are large changes in production/standard of living over time.
The same is true across countries
When talking about economic growth we mean growth of real GDP…

Question 29

Economic growth - Compounding

Answer 29

Annual growth rates that seem small become large when compounded for many years.
Compounding refers to the accumulation of a growth rate over a period of time.

Question 30

Australia and compounding

Answer 30

In Australia between 1950 and 2011, average income, as measured by real GDP per person, has grown by about 1.9 percent per year.
This has led to a 3.2 times increase in the real GDP per capita (living standards)

Question 31

The production function

Answer 31

Y = F(L, K, H, N, A) 
Y = quantity of output
F( ) is a function that shows how the inputs are combined - available production technology
L = quantity of labour
K = quantity of physical capital
H = quantity of (intangible) human capital
N = quantity of natural resources
A = (intangible) technological knowledge

Question 32

Production functions basic explanation

Answer 32

Economists often use a production function to describe the relationship between the quantity of inputs used in production and the quantity of output from production.
The inputs used to produce goods and services are called the factors of production

Question 33

L

Answer 33

We are more interested in the values ‘per worker’ (per capita).
We want to divide everything by L.
L can have different effects on the production function – we distinguish between constant, increasing, and decreasing returns to scale

Question 34

Constant returns to scale

Answer 34

A production function has constant returns to scale if, for any positive number x,
xY = F(xL, xK, xN, H, A)
That is, a doubling of all inputs causes the amount of output to double as well

Question 35

Productivity

Answer 35

The factors of production directly determine productivity.
natural resources, N
physical capital, K
human capital, H
technological knowledge, A

The data shows that sustained economic growth per capita is all about productivity (efficiency), A and H
While N and K are important, their effect on growth disappears over time.

Question 36

The Effect of K

Answer 36

One way to raise productivity is to invest more current resources in the production of capital

Question 37

Diminishing Returns

Answer 37

However, as the stock of capital rises, the extra output produced from an additional unit of capital falls; this property is called diminishing returns (to capital) Because of diminishing returns, an increase in the saving rate leads to higher growth only for a while

Question 38

Diminishing returns and the catch-up effect

Answer 38

In the long run, the higher saving rate leads to a higher level of productivity and income, but not to higher growth in these variables
The catch-up effect refers to the property whereby countries that start off poor tend to grow more rapidly than countries that start off rich
It is often called ‘convergence’ across countries (as opposed to ‘divergence’ which refers to a widening gap between countries)

Question 39

The Effect of H

Answer 39

In Australia, each year of schooling raises a person’s wage, on average, by about 8 percent. Thus, one way the government can enhance the standard of living is to provide schools and encourage the population to take advantage of them.

Question 40

The effect of A

Answer 40

The advance of technological knowledge has led to higher standards of living.
Most technological advance comes from private research by firms and individual inventors.
Government can encourage the development of new technologies through research grants, tax breaks, and the patent system

Question 41

Economic growth and public policy

Answer 41

What are the government policies that can raise productivity and living standards (Y/L)?
encourage saving?
encourage investment into physical capital?
encourage investment from abroad?
encourage education and training?
promote research and development?
establish secure property rights and maintain political stability?
promote free trade?
Immigration?

Question 42

Productivity definition

Answer 42

The quantity of goods and services that a worker can produce for each hour of work.

Question 43

Surplus of labour

Answer 43

Photo in favourites 16/8

Question 44

Rule of 70

Answer 44

70/growth rate = no. of years it takes to double

Question 45

Efficiency wages are:

a. one explanation for the natural rate of unemployment
b. wages paid for time–motion studies
c. the lowest wage an employer can pay
d. none of the above

Answer 45

a

Question 46

Efficiency wages are one explanation for the natural rate of unemployment

Answer 46

Efficiency wages are a wage level that is set intentionally above the equilibrium wage rate in the economy in order to promote and improve worker productivity. Because efficiency wages imply wages above a market clearing or equilibrium wage rate, efficiency wages always result in a surplus of available labour supply and so explains the presence of some structural unemployment and frictional unemployment, which are the two types of unemployment that the natural rate of unemployment is comprised of

Question 47

categories of unemployment

Answer 47

Natural rate of unemployment (long run)

Cyclical rate of unemployment (short run)

Question 48

Natural rate of unemployment (long run)

Answer 48

Unemployment that does not go away on its own even in the long run (always positive). The amount of unemployment that the economy normally (on average) experiences.

Question 49

Cyclical rate of unemployment (short run)

Answer 49

Year to year fluctuations in unemployment around its natural rate. Associated with the short term ups and downs of the business cycle

Question 50

Classical unemployment

Answer 50

The real wage in the labour market is above the market clearing level that equates supply of and demand for labour.

Question 51

Although technological knowledge and human capital are closely related, there is an important difference. Which of the following statements is correct?

a. Human capital is the society’s understanding about how the world works, whereas technological knowledge is the resources spent transmitting this understanding to the labour force
b. Technological knowledge is the bridge that links physical and natural resources with human capital

c. Technological knowledge is the society’s
understanding about how the world works, whereas human capital is the resources spent transmitting this understanding to the labour force

d. Technological knowledge is the society’s understanding of human capital

Answer 51

C

Question 52

8. The production function is given as Y = F(L, K, N, H, A ), where Y is the quantity of output, A is the level of available production technology, L is the quantity of labour, H is the quantity of human capital and N is the quantity of natural resources. This equation provides:
   a. a summary for the four determinants of productivity
   b. a summary for the four determinants of production
   c. a foundation for measuring inflation
   d. a measure of the availability of natural resources

Answer 52

B

Question 53

8. The production function is given as Y = F(L, K, N, H, A ), where Y is the quantity of output, A is the level of available production technology, L is the quantity of labour, H is the quantity of human capital and N is the quantity of natural resources. This equation provides a summary for the four determinants of production

Answer 53

These determinants are the factors of production or inputs used in the production process and consequently a nation’s particular endowment of these “determinant” factors, does in fact determine the maximum amount of output that the economy is capable of producing.

Question 54

Suppose that a firm is faced with an excess supply of workers. What would the firm do? Explain with standard economic theory and with efficiency wage theory.

Answer 54

a. Standard economic theory: assuming a firm maximises its profit, it should lower wages until the supply of workers is equal to the demand. This will reduce production costs and raise profits.
b. Efficiency-wage theory suggests that it might be profitable for a firm to keep wages above the equilibrium level in order to reduce worker turnover, increase worker quality, increase worker effort, and perhaps to increase worker health and therefore worker productivity.

Question 55

15. Explain when minimum laws are binding and result in unemployment.

Answer 55

When the minimum wage is set above the equilibrium level, the result is unemployment. Minimum wages are binding most often for the least skilled and least experienced members of the labour force.