lecture 8 the big ideas in macroeconomics. 19301935 194 0...

LECTURE 8LECTURE 8LECTURE 8LECTURE 8

The Big Ideas in The Big Ideas in MacroeconomicsMacroeconomicsThe Big Ideas in The Big Ideas in MacroeconomicsMacroeconomics

19301930 19351935 194 0 194 0 19451945 19501950 19551955 19601960 19651965 19701970 19751975 19751975 19801980 19851985 19901990

0 0

2,0002,000

4,0004,000

6,0006,000

8,0008,000

U.S. REAL GDP, 1930 - 1990U.S. REAL GDP, 1930 - 1990Real GDPReal GDP1992 $$1992 $$

YEARYEAR

Source: U.S. Department of CommerceSource: U.S. Department of Commerce

U.S. REAL GDPU.S. REAL GDPU.S. REAL GDPU.S. REAL GDP• The data for real GDP control for changes in prices and The data for real GDP control for changes in prices and

thus capture movements in real output onlythus capture movements in real output only• Real GDP has grown substantially over the period Real GDP has grown substantially over the period

graphedgraphed• This is what economists term This is what economists term economic growtheconomic growth: :

sustained increases in real production of an economy sustained increases in real production of an economy over a period of timeover a period of time

• Differences in economic growth between countries and Differences in economic growth between countries and changes in economic growth over time are among the changes in economic growth over time are among the most important issues of macroeconomicsmost important issues of macroeconomics

• The data for real GDP control for changes in prices and The data for real GDP control for changes in prices and thus capture movements in real output onlythus capture movements in real output only

• Real GDP has grown substantially over the period Real GDP has grown substantially over the period graphedgraphed

• This is what economists term This is what economists term economic growtheconomic growth: : sustained increases in real production of an economy sustained increases in real production of an economy over a period of timeover a period of time

• Differences in economic growth between countries and Differences in economic growth between countries and changes in economic growth over time are among the changes in economic growth over time are among the most important issues of macroeconomicsmost important issues of macroeconomics

GROWTH RATESGROWTH RATESGROWTH RATESGROWTH RATES• The growth rate of a variable is the The growth rate of a variable is the

percentage change in the variable from percentage change in the variable from one period to anotherone period to another

• If GDP was 100 in year 1, and 104 in year 2:If GDP was 100 in year 1, and 104 in year 2:

growth rate = percentage changegrowth rate = percentage change

= change in GDP / initial GDP= change in GDP / initial GDP

= ( GDP year 2 - GDP year 1) / GDP year 1= ( GDP year 2 - GDP year 1) / GDP year 1

= ( 104 - 100 ) / 100= ( 104 - 100 ) / 100

= 4 / 100 = .04 = 4%= 4 / 100 = .04 = 4%

• The growth rate of a variable is the The growth rate of a variable is the percentage change in the variable from percentage change in the variable from one period to anotherone period to another


growth rate = percentage changegrowth rate = percentage change

= change in GDP / initial GDP= change in GDP / initial GDP


= ( 104 - 100 ) / 100= ( 104 - 100 ) / 100

= 4 / 100 = .04 = 4%= 4 / 100 = .04 = 4%

GROWTH RATESGROWTH RATESGROWTH RATESGROWTH RATES• May be negative as well as positive;May be negative as well as positive;


growth rate = change in GDP / initial GDPgrowth rate = change in GDP / initial GDP


= ( 100 - 104 ) / 104= ( 100 - 104 ) / 104

= - 4 / 104 = -0.38 = -3.8%= - 4 / 104 = -0.38 = -3.8%

• May be negative as well as positive;May be negative as well as positive;


growth rate = change in GDP / initial GDPgrowth rate = change in GDP / initial GDP


= ( 100 - 104 ) / 104= ( 100 - 104 ) / 104

= - 4 / 104 = -0.38 = -3.8%= - 4 / 104 = -0.38 = -3.8%

GROWTH RATESGROWTH RATESGROWTH RATESGROWTH RATES• If we know the growth rate and the initial GDP If we know the growth rate and the initial GDP

value, we can also calculate the GDP for the next value, we can also calculate the GDP for the next periodperiod

• ““g’ is the growth rate, g’ is the growth rate,

GDP year 2 = ( 1 + g ) GDP year 2 = ( 1 + g ) ** GDP year 1 GDP year 1

• GDP in the second year is 1 plus the growth rate GDP in the second year is 1 plus the growth rate times GDP in the first year;times GDP in the first year;

• If g = 4% and GDP in year 1 were 100,If g = 4% and GDP in year 1 were 100,

GDP year 2 = ( 1 + 0.04) GDP year 2 = ( 1 + 0.04) ** 100 = 104 100 = 104

• If we know the growth rate and the initial GDP If we know the growth rate and the initial GDP value, we can also calculate the GDP for the next value, we can also calculate the GDP for the next periodperiod

• ““g’ is the growth rate, g’ is the growth rate,

GDP year 2 = ( 1 + g ) GDP year 2 = ( 1 + g ) ** GDP year 1 GDP year 1

• GDP in the second year is 1 plus the growth rate GDP in the second year is 1 plus the growth rate times GDP in the first year;times GDP in the first year;

• If g = 4% and GDP in year 1 were 100,If g = 4% and GDP in year 1 were 100,

GDP year 2 = ( 1 + 0.04) GDP year 2 = ( 1 + 0.04) ** 100 = 104 100 = 104

GROWTH RATESGROWTH RATESGROWTH RATESGROWTH RATES• If the economy grew at a rate If the economy grew at a rate gg for for nn years, and the years, and the

economy started at 100, the formula for real GDP economy started at 100, the formula for real GDP after after nn years would be years would be

GDP [n years later] = ( 1 + g ) GDP [n years later] = ( 1 + g ) n n ** (100) (100)

• If the economy starts at 100 and grows at a rate of If the economy starts at 100 and grows at a rate of 4% for 10 years4% for 10 years

GDP [10 years later] = ( 1 + 0.04 ) GDP [10 years later] = ( 1 + 0.04 ) 10 10 ** (100) (100)

= 148= 148• This is nearly 50% higher than in the first year. This is nearly 50% higher than in the first year.

• If the economy grew at a rate If the economy grew at a rate gg for for nn years, and the years, and the economy started at 100, the formula for real GDP economy started at 100, the formula for real GDP after after nn years would be years would be

GDP [n years later] = ( 1 + g ) GDP [n years later] = ( 1 + g ) n n ** (100) (100)

• If the economy starts at 100 and grows at a rate of If the economy starts at 100 and grows at a rate of 4% for 10 years4% for 10 years

GDP [10 years later] = ( 1 + 0.04 ) GDP [10 years later] = ( 1 + 0.04 ) 10 10 ** (100) (100)

= 148= 148• This is nearly 50% higher than in the first year. This is nearly 50% higher than in the first year.

RULE OF 70RULE OF 70RULE OF 70RULE OF 70• If you knew the constant growth rate of If you knew the constant growth rate of

real GDP but wanted to know how many real GDP but wanted to know how many years it would take until the level of real years it would take until the level of real GDP doubledGDP doubled

• years to double = 70 / percentage growth years to double = 70 / percentage growth raterate

• If growth rate were 5%If growth rate were 5%

Years to double = 70 / 5 = 14 yearsYears to double = 70 / 5 = 14 years

• If you knew the constant growth rate of If you knew the constant growth rate of real GDP but wanted to know how many real GDP but wanted to know how many years it would take until the level of real years it would take until the level of real GDP doubledGDP doubled

• years to double = 70 / percentage growth years to double = 70 / percentage growth raterate

• If growth rate were 5%If growth rate were 5%

Years to double = 70 / 5 = 14 yearsYears to double = 70 / 5 = 14 years

STARTING IN 1960, HOW MANY YEARS IT TOOK FOR GDP TO DOUBLE

5

10

15

20

25

YEARS

17.019.0

8.0

24.0

14.0

BelgiumBelgium GermanyGermany JapanJapan United StatesUnited States CanadaCanada

GROWTH AND PRODUCTIVITYGROWTH AND PRODUCTIVITYGROWTH AND PRODUCTIVITYGROWTH AND PRODUCTIVITY

• Economic growth in the US has slowed Economic growth in the US has slowed down:down:

-- from 1950 to 1973, real GDP grew at an annual rate of -- from 1950 to 1973, real GDP grew at an annual rate of 3%3%

-- from 1974 to 1995, real GDP grew at an annual rate of -- from 1974 to 1995, real GDP grew at an annual rate of 1.9%1.9%

• The decline in growth rate of real GDP in The decline in growth rate of real GDP in the US was also associated with a decline the US was also associated with a decline in the growth of labour productivity.in the growth of labour productivity.

• Economic growth in the US has slowed Economic growth in the US has slowed down:down:

-- from 1950 to 1973, real GDP grew at an annual rate of -- from 1950 to 1973, real GDP grew at an annual rate of 3%3%

-- from 1974 to 1995, real GDP grew at an annual rate of -- from 1974 to 1995, real GDP grew at an annual rate of 1.9%1.9%

• The decline in growth rate of real GDP in The decline in growth rate of real GDP in the US was also associated with a decline the US was also associated with a decline in the growth of labour productivity.in the growth of labour productivity.

LABOR PRODUCTIVITYLABOR PRODUCTIVITYLABOR PRODUCTIVITYLABOR PRODUCTIVITY

• The amount of output produced per The amount of output produced per workerworker

• It gives us an idea of how much is It gives us an idea of how much is produced by the average workerproduced by the average worker

• Living standards can rise over time Living standards can rise over time only if more output is produced by only if more output is produced by the average workerthe average worker

• The amount of output produced per The amount of output produced per workerworker

• It gives us an idea of how much is It gives us an idea of how much is produced by the average workerproduced by the average worker

• Living standards can rise over time Living standards can rise over time only if more output is produced by only if more output is produced by the average workerthe average worker

PRODUCTIVITY SLOWDOWNPRODUCTIVITY SLOWDOWNPRODUCTIVITY SLOWDOWNPRODUCTIVITY SLOWDOWN

• Although productivity may continue to Although productivity may continue to grow during a period, it grows at a slower grow during a period, it grows at a slower raterate

• This also means that wages and salaries This also means that wages and salaries have not grown as fast as they had in the have not grown as fast as they had in the pastpast

• Although productivity may continue to Although productivity may continue to grow during a period, it grows at a slower grow during a period, it grows at a slower raterate

• This also means that wages and salaries This also means that wages and salaries have not grown as fast as they had in the have not grown as fast as they had in the pastpast

PP

T T

P: peak of recessionsT: trough of recessions

Source: U.S. Department of Commerce

RECESSIONRECESSIONRECESSIONRECESSION

• A period when economic growth is A period when economic growth is negative (real GDP falls) for two negative (real GDP falls) for two consecutive quartersconsecutive quarters

• A quarter is three consecutive months A quarter is three consecutive months during the yearduring the year

• A recession is a period when real GDP A recession is a period when real GDP falls for at least six monthsfalls for at least six months

• A period when economic growth is A period when economic growth is negative (real GDP falls) for two negative (real GDP falls) for two consecutive quartersconsecutive quarters

• A quarter is three consecutive months A quarter is three consecutive months during the yearduring the year

• A recession is a period when real GDP A recession is a period when real GDP falls for at least six monthsfalls for at least six months

RECESSIONRECESSIONRECESSIONRECESSIONPeakPeak• The date at which a recession startsThe date at which a recession starts

TroughTrough• The date at which output starts to The date at which output starts to

increase againincrease again Since World War II, the United States has experienced Since World War II, the United States has experienced

nine recessions.nine recessions.

PeakPeak• The date at which a recession startsThe date at which a recession starts

TroughTrough• The date at which output starts to The date at which output starts to

increase againincrease again Since World War II, the United States has experienced Since World War II, the United States has experienced

nine recessions.nine recessions.

NINE POSTWAR RECESSIONSNINE POSTWAR RECESSIONSNINE POSTWAR RECESSIONSNINE POSTWAR RECESSIONS

PeakPeak TroughTrough Percent Decline in Percent Decline in real GDPreal GDP

November 1948November 1948 October 1949October 1949 1.51.5

July 1953July 1953 May 1954May 1954 3.23.2

August 1957August 1957 April 1958April 1958 3.33.3

April 1960April 1960 February 1961February 1961 1.21.2

December 1969December 1969 November 1970November 1970 1.01.0

November 1973November 1973 March 1975March 1975 4.94.9

January 1980January 1980 July 1980July 1980 2.52.5

July 1981July 1981 November 1982November 1982 3.03.0

July 1990July 1990 March 1991March 1991 1.41.4

PeakPeak TroughTrough Percent Decline in Percent Decline in real GDPreal GDP

November 1948November 1948 October 1949October 1949 1.51.5

July 1953July 1953 May 1954May 1954 3.23.2

August 1957August 1957 April 1958April 1958 3.33.3

April 1960April 1960 February 1961February 1961 1.21.2

December 1969December 1969 November 1970November 1970 1.01.0

November 1973November 1973 March 1975March 1975 4.94.9

January 1980January 1980 July 1980July 1980 2.52.5

July 1981July 1981 November 1982November 1982 3.03.0

July 1990July 1990 March 1991March 1991 1.41.4

• A common term for a severe recessionA common term for a severe recession• In the United States, the Great Depression refers to the In the United States, the Great Depression refers to the

1929 - 1933 period, in which real GDP fell by over 33%1929 - 1933 period, in which real GDP fell by over 33%• It created the most severe economic dislocations that It created the most severe economic dislocations that

the United States has experienced in the twentieth the United States has experienced in the twentieth centurycentury

• Banks closed, businesses failed, and many people lost Banks closed, businesses failed, and many people lost their life savingstheir life savings

• Unemployment rose sharplyUnemployment rose sharply• In 1933, over 25% of the people looking for work failed In 1933, over 25% of the people looking for work failed

to find jobsto find jobs

• A common term for a severe recessionA common term for a severe recession• In the United States, the Great Depression refers to the In the United States, the Great Depression refers to the

1929 - 1933 period, in which real GDP fell by over 33%1929 - 1933 period, in which real GDP fell by over 33%• It created the most severe economic dislocations that It created the most severe economic dislocations that

the United States has experienced in the twentieth the United States has experienced in the twentieth centurycentury

• Banks closed, businesses failed, and many people lost Banks closed, businesses failed, and many people lost their life savingstheir life savings

• Unemployment rose sharplyUnemployment rose sharply• In 1933, over 25% of the people looking for work failed In 1933, over 25% of the people looking for work failed

to find jobsto find jobs

DEPRESSIONDEPRESSIONDEPRESSIONDEPRESSION

CAUSES OF RECESSIONCAUSES OF RECESSIONCAUSES OF RECESSIONCAUSES OF RECESSION• Changes in technologyChanges in technology

• Disruptions to the financial systemDisruptions to the financial system

• Increases in prices of key commoditiesIncreases in prices of key commodities

• (Deliberate or inadvertent) government (Deliberate or inadvertent) government policiespolicies

• Changes in technologyChanges in technology

• Disruptions to the financial systemDisruptions to the financial system

• Increases in prices of key commoditiesIncreases in prices of key commodities

• (Deliberate or inadvertent) government (Deliberate or inadvertent) government policiespolicies

KEYNESIAN ECONOMICSKEYNESIAN ECONOMICSKEYNESIAN ECONOMICSKEYNESIAN ECONOMICS

The study of business The study of business cycles and economic cycles and economic fluctuations that we fluctuations that we develop.develop.

The study of business The study of business cycles and economic cycles and economic fluctuations that we fluctuations that we develop.develop.

CLASSICAL ECONOMICSCLASSICAL ECONOMICSCLASSICAL ECONOMICSCLASSICAL ECONOMICS

• The study of how the economy operates at full The study of how the economy operates at full employment;employment;

• Based on the principle that prices will adjust Based on the principle that prices will adjust in the long run to bring markets for goods and in the long run to bring markets for goods and labour into equilibrium;labour into equilibrium;

• Classical economists believed that economic Classical economists believed that economic episodes of boom and bust were transitory episodes of boom and bust were transitory and economy would return to full employment.and economy would return to full employment.

• The study of how the economy operates at full The study of how the economy operates at full employment;employment;

• Based on the principle that prices will adjust Based on the principle that prices will adjust in the long run to bring markets for goods and in the long run to bring markets for goods and labour into equilibrium;labour into equilibrium;

• Classical economists believed that economic Classical economists believed that economic episodes of boom and bust were transitory episodes of boom and bust were transitory and economy would return to full employment.and economy would return to full employment.

SUPPLY-SIDE ECONOMICSSUPPLY-SIDE ECONOMICSSUPPLY-SIDE ECONOMICSSUPPLY-SIDE ECONOMICS

A school of thought that A school of thought that emphasizes how changes in taxes emphasizes how changes in taxes affect economic activity.affect economic activity.

A school of thought that A school of thought that emphasizes how changes in taxes emphasizes how changes in taxes affect economic activity.affect economic activity.

FULL EMPLOYMENTFULL EMPLOYMENTFULL EMPLOYMENTFULL EMPLOYMENT

• Corresponds to zero cyclical Corresponds to zero cyclical unemployment;unemployment;

• When the economy is at full When the economy is at full employment, the only unemployment employment, the only unemployment is frictional and structural.is frictional and structural.

• Corresponds to zero cyclical Corresponds to zero cyclical unemployment;unemployment;

• When the economy is at full When the economy is at full employment, the only unemployment employment, the only unemployment is frictional and structural.is frictional and structural.

AGGREGATE PRODUCTION FUNCTIONAGGREGATE PRODUCTION FUNCTIONAGGREGATE PRODUCTION FUNCTIONAGGREGATE PRODUCTION FUNCTION Explains the relationship of the total inputs used Explains the relationship of the total inputs used

throughout the economy to the level of production in the throughout the economy to the level of production in the economy or GDP.economy or GDP.

• There are two primary factors of production: capital and There are two primary factors of production: capital and labour;labour;

• the the stock of capitalstock of capital comprises all the machines, comprises all the machines, equipment and buildings in the entire economy;equipment and buildings in the entire economy;

• LabourLabour consists of the effort of all workers in the consists of the effort of all workers in the economy;economy;

Y = F ( K,L )Y = F ( K,L )

YY is total output or GDP; is total output or GDP;

KK is the stock of capital; is the stock of capital;

LL is the labour force. is the labour force.

Explains the relationship of the total inputs used Explains the relationship of the total inputs used throughout the economy to the level of production in the throughout the economy to the level of production in the economy or GDP.economy or GDP.

• There are two primary factors of production: capital and There are two primary factors of production: capital and labour;labour;

• the the stock of capitalstock of capital comprises all the machines, comprises all the machines, equipment and buildings in the entire economy;equipment and buildings in the entire economy;

• LabourLabour consists of the effort of all workers in the consists of the effort of all workers in the economy;economy;

Y = F ( K,L )Y = F ( K,L )

YY is total output or GDP; is total output or GDP;

KK is the stock of capital; is the stock of capital;

LL is the labour force. is the labour force.

SHORT-RUN PRODUCTION SHORT-RUN PRODUCTION FUNCTIONFUNCTION

SHORT-RUN PRODUCTION SHORT-RUN PRODUCTION FUNCTIONFUNCTION

Shows the relationship between Shows the relationship between the amount of labour used in an the amount of labour used in an economy and the total level of economy and the total level of output with a fixed stock of capital output with a fixed stock of capital ( K ( K** ). ).

Shows the relationship between Shows the relationship between the amount of labour used in an the amount of labour used in an economy and the total level of economy and the total level of output with a fixed stock of capital output with a fixed stock of capital ( K ( K** ). ).

RELATIONSHIP BETWEEN LABOUR AND OUTPUTRELATIONSHIP BETWEEN LABOUR AND OUTPUTWITH FIXED CAPITALWITH FIXED CAPITAL

Total OutputTotal Output( Y )( Y )

YY1 1

LL11 Labour Force Labour Force



YY2 2

YY1 1

LL11 LL22 Labour Force Labour Force



YY2 2

YY1 1

LL11 LL22 Labour Force Labour Force

With capital fixed, output increases with labour input but at aWith capital fixed, output increases with labour input but at adecreasing rate. decreasing rate.

PRINCIPLE OF DIMINISHING PRINCIPLE OF DIMINISHING RETURNSRETURNS

PRINCIPLE OF DIMINISHING PRINCIPLE OF DIMINISHING RETURNSRETURNS

Suppose output is produced with two or Suppose output is produced with two or more inputs and we increase one input more inputs and we increase one input while holding other inputs fixed, beyond while holding other inputs fixed, beyond some point -- called the point of diminishing some point -- called the point of diminishing returns -- output will increase at a returns -- output will increase at a decreasing rate.decreasing rate.

Suppose output is produced with two or Suppose output is produced with two or more inputs and we increase one input more inputs and we increase one input while holding other inputs fixed, beyond while holding other inputs fixed, beyond some point -- called the point of diminishing some point -- called the point of diminishing returns -- output will increase at a returns -- output will increase at a decreasing rate.decreasing rate.

OUTPUT AND LABOUR OUTPUT AND LABOUR INPUTINPUT

OUTPUT AND LABOUR OUTPUT AND LABOUR INPUTINPUT

Y ( Output )Y ( Output ) L ( Labour Input )L ( Labour Input )

1010 3 3

1515 4 4

1919 5 5

2222 6 6

Y ( Output )Y ( Output ) L ( Labour Input )L ( Labour Input )

1010 3 3

1515 4 4

1919 5 5

2222 6 6



INCREASE IN THE STOCK OF CAPITALINCREASE IN THE STOCK OF CAPITAL

KK* *



INCREASE IN THE STOCK OF CAPITALINCREASE IN THE STOCK OF CAPITAL

KK* *

KK* * * *

When capital increases from K* to K* *, the production function shifts up; at any level of labour input, the level of output increases.

REAL WAGE RATEREAL WAGE RATEREAL WAGE RATEREAL WAGE RATE

The wage rate adjusted The wage rate adjusted for inflation.for inflation.

The wage rate adjusted The wage rate adjusted for inflation.for inflation.

DEMAND FOR LABOURDEMAND FOR LABOURDEMAND FOR LABOURDEMAND FOR LABOUR

• Firms hire labour to produce output Firms hire labour to produce output and make profits;and make profits;

• The amount of labour they hire The amount of labour they hire depends on the real wage rate;depends on the real wage rate;

• Firms use the Marginal Principle in Firms use the Marginal Principle in hiring labour; hiring labour;

• Firms hire labour to produce output Firms hire labour to produce output and make profits;and make profits;

• The amount of labour they hire The amount of labour they hire depends on the real wage rate;depends on the real wage rate;

• Firms use the Marginal Principle in Firms use the Marginal Principle in hiring labour; hiring labour;

THE MARGINAL PRINCIPLETHE MARGINAL PRINCIPLETHE MARGINAL PRINCIPLETHE MARGINAL PRINCIPLE

Increase the level of activity if its Increase the level of activity if its marginal benefit exceeds its marginal marginal benefit exceeds its marginal cost, but reduce the level if marginal cost, but reduce the level if marginal cost exceeds the marginal benefit. If cost exceeds the marginal benefit. If possible, pick the level at which the possible, pick the level at which the marginal benefit equals the marginal marginal benefit equals the marginal cost. cost.

Increase the level of activity if its Increase the level of activity if its marginal benefit exceeds its marginal marginal benefit exceeds its marginal cost, but reduce the level if marginal cost, but reduce the level if marginal cost exceeds the marginal benefit. If cost exceeds the marginal benefit. If possible, pick the level at which the possible, pick the level at which the marginal benefit equals the marginal marginal benefit equals the marginal cost. cost.

DEMAND FOR AND SUPPLY OF LABOURDEMAND FOR AND SUPPLY OF LABOUR

REAL WAGEREAL WAGE$$ / HR$$ / HR

LABOURLABOUR


LABOURLABOUR


LABOURLABOURDemand for LabourDemand for Labour Supply of LabourSupply of Labour Demand for and Demand for and

Supply of Labour Supply of Labour

A B C



1010

100LABOURLABOUR


1010

50LABOURLABOUR




A B C



2020

1010

50 100LABOURLABOUR


2020

1010

50 100LABOURLABOUR




A B C



2020

1010

50 100LABOURLABOUR


2020

1010

50 100LABOURLABOUR


LABOURLABOUR

LabourLabourDemandDemand LabourLabour

SupplySupply


SupplySupply

Demand for LabourDemand for Labour Supply of LabourSupply of Labour Demand for and Demand for and Supply of Labour Supply of Labour

A B C



2020

1010

50 100LABOURLABOUR


2020

1010

50 100LABOURLABOUR


1515

75

LABOURLABOUR


SupplySupply


SupplySupply

Demand for LabourDemand for Labour Supply of LabourSupply of Labour Demand for and Demand for and Supply of Labour Supply of Labour

A B C

LABOUR SUPPLY CURVELABOUR SUPPLY CURVELABOUR SUPPLY CURVELABOUR SUPPLY CURVE

• Based on decisions of Based on decisions of workers;workers;

• They must decide how many They must decide how many hours they wish to work hours they wish to work versus how much leisure time versus how much leisure time they wish to enjoy;they wish to enjoy;

• Based on decisions of Based on decisions of workers;workers;

• They must decide how many They must decide how many hours they wish to work hours they wish to work versus how much leisure time versus how much leisure time they wish to enjoy;they wish to enjoy;

SUBSTITUTION EFFECTSUBSTITUTION EFFECTSUBSTITUTION EFFECTSUBSTITUTION EFFECT

• An increase in real wage rate will An increase in real wage rate will make working more attractive and make working more attractive and raise the opportunity cost of not raise the opportunity cost of not working;working;

• It leads to workers wanting to supply It leads to workers wanting to supply more hours.more hours.

• An increase in real wage rate will An increase in real wage rate will make working more attractive and make working more attractive and raise the opportunity cost of not raise the opportunity cost of not working;working;

• It leads to workers wanting to supply It leads to workers wanting to supply more hours.more hours.

• A higher wage rate raises a worker’s A higher wage rate raises a worker’s income for the amount of hours that he or income for the amount of hours that he or she is currently working;she is currently working;

• As income rises, a worker may choose to As income rises, a worker may choose to enjoy more leisure and work fewer hours.enjoy more leisure and work fewer hours.

• A higher wage rate raises a worker’s A higher wage rate raises a worker’s income for the amount of hours that he or income for the amount of hours that he or she is currently working;she is currently working;

• As income rises, a worker may choose to As income rises, a worker may choose to enjoy more leisure and work fewer hours.enjoy more leisure and work fewer hours.

INCOME EFFECTINCOME EFFECTINCOME EFFECTINCOME EFFECT

INCOME AND INCOME AND SUBSTITUTION EFFECTSSUBSTITUTION EFFECTS

INCOME AND INCOME AND SUBSTITUTION EFFECTSSUBSTITUTION EFFECTS

• In principle, a higher wage could lead In principle, a higher wage could lead workers to supply either greater or workers to supply either greater or fewer hours of work;fewer hours of work;

• In our analysis, we assume that the In our analysis, we assume that the substitution effect dominates:substitution effect dominates:

• A higher wage will lead to increases A higher wage will lead to increases in the supply of labour. in the supply of labour.

• In principle, a higher wage could lead In principle, a higher wage could lead workers to supply either greater or workers to supply either greater or fewer hours of work;fewer hours of work;

• In our analysis, we assume that the In our analysis, we assume that the substitution effect dominates:substitution effect dominates:

• A higher wage will lead to increases A higher wage will lead to increases in the supply of labour. in the supply of labour.

Labour Labour

Real Wages Real Wages

SHIFTS IN DEMAND AND SUPPLYSHIFTS IN DEMAND AND SUPPLY

Labour Supply

Labour Demand

Labour Demand

LabourSupply

E E

A B

Labour Labour



Labour Supply

Original Labour Demand

Increased LabourDemand

Labour Demand

E E

A B

Labour Labour



Labour Supply



Labour Demand

Original LabourSupply

E E

E1

A B

Labour Labour



If demand for labour increases, real wages rise and the amount of labour employed increases

Labour Supply



Labour Demand

LabourSupply

E E

E1

A B

Labour Labour



Labour Supply



Labour Demand

Original LabourSupply Increased

Labour SupplyE E


E1

A B

Labour Labour



Labour Supply



Labour Demand


Labour SupplyE E

E1

E1


A B

Labour Labour




If supply of labour increases,real wages fall but the amount of labour employed increases

Labour Supply



Labour Demand


Labour SupplyE E

E1

E1

A B

FULL-EMPLOYMENT OUTPUTFULL-EMPLOYMENT OUTPUTFULL-EMPLOYMENT OUTPUTFULL-EMPLOYMENT OUTPUT• The level of output produced when the The level of output produced when the

labour market is in equilibrium;labour market is in equilibrium;

• It is also known as the It is also known as the potential outputpotential output;;

• Measuring full-employment output:Measuring full-employment output: -- estimate unemployment if cyclical -- estimate unemployment if cyclical

unemployment were zero (i.e., only unemployment were zero (i.e., only frictional and structural factors);frictional and structural factors);

economists have estimated 5 - 6.5% in U.S.economists have estimated 5 - 6.5% in U.S.

-- estimate how many workers will be employed;-- estimate how many workers will be employed;

-- apply short-run production function to -- apply short-run production function to determine potential output;determine potential output;

• The level of output produced when the The level of output produced when the labour market is in equilibrium;labour market is in equilibrium;

• It is also known as the It is also known as the potential outputpotential output;;

• Measuring full-employment output:Measuring full-employment output: -- estimate unemployment if cyclical -- estimate unemployment if cyclical

unemployment were zero (i.e., only unemployment were zero (i.e., only frictional and structural factors);frictional and structural factors);

economists have estimated 5 - 6.5% in U.S.economists have estimated 5 - 6.5% in U.S.

-- estimate how many workers will be employed;-- estimate how many workers will be employed;

-- apply short-run production function to -- apply short-run production function to determine potential output;determine potential output;

Real Real WageWage

LabourLabour

Labour SupplyLabour Supply

DETERMINING FULL-EMPLOYMENTOUTPUT

Real Real WageWage

LabourLabour

Labour DemandLabour Demand



Real Real WageWage

W*W*

LL** LabourLabour




OutputOutput

Real Real WageWage

W*W*

LL** LabourLabour



LabourLabour


OutputOutput

Y*Y*

Real Real WageWage

W*W*

LL**

LL** LabourLabour



LabourLabour


LAFFER CURVELAFFER CURVELAFFER CURVELAFFER CURVE• Named after economist Arthur Laffer;Named after economist Arthur Laffer;

Supply-side economist -- one who emphasizes the Supply-side economist -- one who emphasizes the adverse effects of taxation on potential output; adverse effects of taxation on potential output;

• Laffer curve shows the relationship between the tax Laffer curve shows the relationship between the tax rate that a government levies and total tax revenue that rate that a government levies and total tax revenue that the government collects;the government collects;

• The total amount of revenue a government collects The total amount of revenue a government collects depends on both the tax rate and the level of economic depends on both the tax rate and the level of economic activity;activity;

• Laffer curve illustrates that high tax rates may not Laffer curve illustrates that high tax rates may not bring in much revenue if economic activity decreases.bring in much revenue if economic activity decreases.

• Named after economist Arthur Laffer;Named after economist Arthur Laffer;

Supply-side economist -- one who emphasizes the Supply-side economist -- one who emphasizes the adverse effects of taxation on potential output; adverse effects of taxation on potential output;

• Laffer curve shows the relationship between the tax Laffer curve shows the relationship between the tax rate that a government levies and total tax revenue that rate that a government levies and total tax revenue that the government collects;the government collects;

• The total amount of revenue a government collects The total amount of revenue a government collects depends on both the tax rate and the level of economic depends on both the tax rate and the level of economic activity;activity;

• Laffer curve illustrates that high tax rates may not Laffer curve illustrates that high tax rates may not bring in much revenue if economic activity decreases.bring in much revenue if economic activity decreases.

Tax RevenuesTax Revenues

Tax RateTax Rate0%0%

LAFFER CURVELAFFER CURVE

At a zero tax rate, the government collects no revenue. At a zero tax rate, the government collects no revenue.




At a zero tax rate, the government collects no revenue. At a zero tax rate, the government collects no revenue. As tax rates rise, revenues increase. As tax rates rise, revenues increase.




At a zero tax rate, the government collects no revenue. At a zero tax rate, the government collects no revenue. As tax rates rise, revenues increase. As tax rates rise, revenues increase.

But at some point, the disincentives from higher taxes cause revenues But at some point, the disincentives from higher taxes cause revenues to fall. to fall.


Tax RateTax Rate0%0% 100%100%


At a zero tax rate, the government collects no revenue. As tax rates rise, At a zero tax rate, the government collects no revenue. As tax rates rise, revenues increase. But at some point, the disincentives from higher revenues increase. But at some point, the disincentives from higher

taxes cause revenues to fall. At a tax rate of 100%, no one will work and taxes cause revenues to fall. At a tax rate of 100%, no one will work and tax revenues will disappear.tax revenues will disappear.

EFFECTS OF TAX PAID BY EFFECTS OF TAX PAID BY EMPLOYERS FOR HIRING LABOUREMPLOYERS FOR HIRING LABOUR

EFFECTS OF TAX PAID BY EFFECTS OF TAX PAID BY EMPLOYERS FOR HIRING LABOUREMPLOYERS FOR HIRING LABOUR

• A tax on labour makes labour more A tax on labour makes labour more expensive and raises marginal cost of expensive and raises marginal cost of hiring workers;hiring workers;

• Since marginal cost has gone up, but Since marginal cost has gone up, but marginal benefit has not changed, marginal benefit has not changed, employers hire fewer workers;employers hire fewer workers;

• Shift left of labour demand leads to lower Shift left of labour demand leads to lower wage and potentially reduced employment;wage and potentially reduced employment;

• A tax on labour makes labour more A tax on labour makes labour more expensive and raises marginal cost of expensive and raises marginal cost of hiring workers;hiring workers;

• Since marginal cost has gone up, but Since marginal cost has gone up, but marginal benefit has not changed, marginal benefit has not changed, employers hire fewer workers;employers hire fewer workers;

• Shift left of labour demand leads to lower Shift left of labour demand leads to lower wage and potentially reduced employment;wage and potentially reduced employment;

RealRealwageswages

RealRealwageswages

LabourLabour LabourLabour

LabourLaboursupplysupplyLabourLabour

supplysupply

Labour demandLabour demandbefore taxbefore tax


EEEE

EFFECTS OF EMPLOYMENT TAXESEFFECTS OF EMPLOYMENT TAXESAA BB

RealRealwageswages

RealRealwageswages



supplysupply



Labour demandLabour demandafter taxafter tax


EEEE


RealRealwageswages

RealRealwageswages



supplysupply





EE

EE11

EE

EE11


RealRealwageswages

RealRealwageswages



supplysupply





EE

EE11

EE

EE11


A tax on labour shifts the demand curve A tax on labour shifts the demand curve left and leads to lower wages andleft and leads to lower wages andreduced employment.reduced employment.

If the supply curve for labour is If the supply curve for labour is vertical, wages fall but vertical, wages fall but employment does not change.employment does not change.

lecture 8 the big ideas in macroeconomics. 19301935 194 0...

Documents

gdp year

gdp initial gdp

anotherif gdp

yearreal gdp

positiveif gdp

growth rate times gdp

real gdp control

real output onlyreal