ln07_osull949330_08_econ_ln07
DESCRIPTION
Chapter 7 of Principles of MacroeconomicsTRANSCRIPT
Chapter 7The Economy at Full Employment
Gross domestic product per capita is higher in the United States than in France. The primary reason for this is that the French (and other Europeans) work one-third fewer hours than do U.S. workers. You might be tempted to attribute this difference to Europeans’ taste for leisure or vacations. However, in the early 1970s Europeans actually worked slightly more hours than did U.S. workers. What explains this dramatic turnaround in the space of just 20 years?
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
Explain the concept of diminishing returns to labor.
Analyze how shifts in demand and supply affect wages and employment.
Explain how full employment is determined in a classical model.
Describe how changes in taxes can affect full employment.
Compare crowding out in a closed and open economy.
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
classical models
Economic models that assume wages and prices adjust freely to changes in demand and supply.
7.1 WAGE AND PRICE FLEXIBILITY
AND FULL EMPLOYMENT
7-*
production function
The relationship between the level of output of a good and the factors of production that are inputs to production.
stock of capital
The total of all machines, equipment, and buildings in an entire economy.
labor
Human effort, including both physical and mental effort, used to produce goods and services.
When there are only two factors of production, capital and labor, the production function is written as follows:
Y = F(K,L)
7-*
The Relationship between Labor and Output with Fixed Capital
With capital fixed, output increases with labor input, but at a decreasing rate.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
P R I N C I P L E O F D I M I N I S H I N G R E T U R N S
Suppose output is produced with two or more inputs, and we increase one input while holding the other input or inputs fixed. Beyond some point—called the point of diminishing returns—output will increase at a decreasing rate.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
An Increase in the Stock of Capital
When the capital increases from K1 to K2, the production function shifts up.
At any level of labor input, the level of output increases.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
real wage
The wage rate paid to employees adjusted for changes in the price level.
Together, the demand and supply for labor determine the level of employment and the real wage.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR
7-*
Labor Market Equilibrium
Panel C of Figure 7.3 puts the demand and supply curves together.
At a wage of $15 per hour, the amount of labor firms want to hire—7,500 workers—will be equal to the number of people who want to work—7,500 workers.
This is the labor market equilibrium: The quantity demanded for labor equals the quantity supplied.
Together, the demand and supply curves determine the level of employment in the economy and the level of real wages.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont.)
7-*
Changes in Demand and Supply
M A R G I N A L P R I N C I P L E
Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.
Shifts to demand and supply will change both real wages and employment.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont.)
7-*
THE BLACK DEATH AND LIVING STANDARDS IN OLD ENGLAND
APPLYING THE CONCEPTS #1: How can changes in the supply of labor affect real wages?
According to the research of Gregory Clark of the UC, Davis, the level of real wages for laborers in England was nearly the same in 1200 as it was in 1800. Yet, during the period from 1350 to 1550, they were higher—nearly 75 percent higher in 1450, for instance, than in 1200.
Why were real wages temporarily so high during this period?
The simple answer was the bubonic plague—also known as the Black Death
Arrived from Asia in 1348 and caused a long decline in total population through the 1450s.
With fewer workers, there was less labor supplied to the market. The result was higher real wages.
In the era before consistent and rapid technological advance, changes in population was the primary factor controlling living standards. As the economist Thomas Malthus (1766–1834) observed, social maladies such as the Black Death would temporarily raise living standards until higher living standards led to increased population.
A P P L I C A T I O N
1
7-*
full-employment output
The level of output that results when the labor market is in equilibrium and the economy is producing at full employment.
Panel B determines the equilibrium level of employment at L and the real wage rate of W. Full-employment output
in Panel A is Y.
7.4 LABOR MARKET EQUILIBRIUM AND FULL EMPLOYMENT
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
Taxes and Potential Output
In Panel A, a tax burden on labor shifts the labor demand curve to the left and leads to lower wages and reduced employment.
In Panel B, the supply curve for labor is vertical, which means that wages fall but employment does not change.
7.5 USING THE FULL-EMPLOYMENT MODEL
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
How an Adverse Technology Shock Affects Labor Demand and Supply
Real Business Cycle Theory
real business cycle theory
The economic theory that emphasizes how shocks to technology can cause fluctuations in economic activity.
An adverse shock to technology will decrease the demand for labor.
As a result, both real wages and employment fall as the market equilibrium moves from a to b.
7.5 USING THE FULL-EMPLOYMENT MODEL (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
DO EUROPEAN SOCCER STARS CHANGE CLUBS TO REDUCE THEIR TAXES?
APPLYING THE CONCEPTS #2: What evidence is there that taxes on high paid soccer stars in Europe affect their location decisions among countries?
In 2009, a Portuguese soccer star moved from Manchester United in the United Kingdom to Real Madrid in Spain. Many speculated that the reason he moved was to avoid a top United Kingdom tax rate of 50 percent in favor of a flat 24 percent rate (with no deductions) created to entice foreigners to locate in Spain. While this is an interesting anecdote, is there any other evidence that the very top earners will move to countries with lower tax rates?
In an interesting study, economists Henrik Jacobsen Kleven, Camille Landais,and Emmanuel Saez used changes in the market for international soccer stars to test for the effects of tax rates. Prior to 1995, the top European soccer clubs had limits on the number of foreign players on any one team. The European Court of Justice, however, ruled that these limits violated the treaty of the European community. The economists found that prior to 1995, taxes on high earners did not have much effect on mobility of soccer stars, but after 1995, top tax rates did matter.
This type of evidence suggests that countries may not only be in competition for top athletes, but also for other highly paid individuals—from tennis players to corporate executives.
A P P L I C A T I O N
2
7-*
CAN LABOR MARKET POLICIES ACCOUNT FOR THE GREAT DEPRESSION?
APPLYING THE CONCEPTS #3: Can real business cycle models explain the origin and persistence of the Great Depression?
Real Business Cycle models do not explain the Great Depression
Economists Cole and Ohanian of UCLA modified the standard model to include other factors.
President Roosevelt’s New Deal allowed firms to collude if they recognized unions and raised wages.
President Hoover also had polices that raised wages.
Incorporating these factors into the model allow it to explain the origin and severity of the Great Depression.
A P P L I C A T I O N
3
7-*
DEMANDS FOR GDP AT FULL EMPLOYMENT
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
crowding out
The reduction in investment (or other component of GDP) caused by an increase in government spending.
P R I N C I P L E O F O P P O RT U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
closed economy
Y = C + I + G
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
FIGURE 7.8
Increased government spending crowds out consumption by consumers.
The vertical bar highlights the time period during which crowding out occurred.
SOURCE: U.S. Department of Commerce.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
FIGURE 7.9
U.S. Investment and Government Spending During World War II
Increased government spending also crowds out private investment spending.
The vertical bar highlights the time period during which crowding out occurred.
SOURCE: U.S. Department of Commerce.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
open economy
Crowding in
crowding in
The increase of investment (or other component of GDP) caused by a decrease in government spending.
Increased government spending need not crowd out either consumption or investment. It could lead to reduced exports and increased imports.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
classical models
closed economy
crowding in
crowding out
full-employment output
Gross domestic product per capita is higher in the United States than in France. The primary reason for this is that the French (and other Europeans) work one-third fewer hours than do U.S. workers. You might be tempted to attribute this difference to Europeans’ taste for leisure or vacations. However, in the early 1970s Europeans actually worked slightly more hours than did U.S. workers. What explains this dramatic turnaround in the space of just 20 years?
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
Explain the concept of diminishing returns to labor.
Analyze how shifts in demand and supply affect wages and employment.
Explain how full employment is determined in a classical model.
Describe how changes in taxes can affect full employment.
Compare crowding out in a closed and open economy.
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
classical models
Economic models that assume wages and prices adjust freely to changes in demand and supply.
7.1 WAGE AND PRICE FLEXIBILITY
AND FULL EMPLOYMENT
7-*
production function
The relationship between the level of output of a good and the factors of production that are inputs to production.
stock of capital
The total of all machines, equipment, and buildings in an entire economy.
labor
Human effort, including both physical and mental effort, used to produce goods and services.
When there are only two factors of production, capital and labor, the production function is written as follows:
Y = F(K,L)
7-*
The Relationship between Labor and Output with Fixed Capital
With capital fixed, output increases with labor input, but at a decreasing rate.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
P R I N C I P L E O F D I M I N I S H I N G R E T U R N S
Suppose output is produced with two or more inputs, and we increase one input while holding the other input or inputs fixed. Beyond some point—called the point of diminishing returns—output will increase at a decreasing rate.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
An Increase in the Stock of Capital
When the capital increases from K1 to K2, the production function shifts up.
At any level of labor input, the level of output increases.
7.2 THE PRODUCTION FUNCTION (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
real wage
The wage rate paid to employees adjusted for changes in the price level.
Together, the demand and supply for labor determine the level of employment and the real wage.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR
7-*
Labor Market Equilibrium
Panel C of Figure 7.3 puts the demand and supply curves together.
At a wage of $15 per hour, the amount of labor firms want to hire—7,500 workers—will be equal to the number of people who want to work—7,500 workers.
This is the labor market equilibrium: The quantity demanded for labor equals the quantity supplied.
Together, the demand and supply curves determine the level of employment in the economy and the level of real wages.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont.)
7-*
Changes in Demand and Supply
M A R G I N A L P R I N C I P L E
Increase the level of an activity as long as its marginal benefit exceeds its marginal cost. Choose the level at which the marginal benefit equals the marginal cost.
Shifts to demand and supply will change both real wages and employment.
7.3 WAGES AND THE DEMAND AND
SUPPLY FOR LABOR (cont.)
7-*
THE BLACK DEATH AND LIVING STANDARDS IN OLD ENGLAND
APPLYING THE CONCEPTS #1: How can changes in the supply of labor affect real wages?
According to the research of Gregory Clark of the UC, Davis, the level of real wages for laborers in England was nearly the same in 1200 as it was in 1800. Yet, during the period from 1350 to 1550, they were higher—nearly 75 percent higher in 1450, for instance, than in 1200.
Why were real wages temporarily so high during this period?
The simple answer was the bubonic plague—also known as the Black Death
Arrived from Asia in 1348 and caused a long decline in total population through the 1450s.
With fewer workers, there was less labor supplied to the market. The result was higher real wages.
In the era before consistent and rapid technological advance, changes in population was the primary factor controlling living standards. As the economist Thomas Malthus (1766–1834) observed, social maladies such as the Black Death would temporarily raise living standards until higher living standards led to increased population.
A P P L I C A T I O N
1
7-*
full-employment output
The level of output that results when the labor market is in equilibrium and the economy is producing at full employment.
Panel B determines the equilibrium level of employment at L and the real wage rate of W. Full-employment output
in Panel A is Y.
7.4 LABOR MARKET EQUILIBRIUM AND FULL EMPLOYMENT
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
Taxes and Potential Output
In Panel A, a tax burden on labor shifts the labor demand curve to the left and leads to lower wages and reduced employment.
In Panel B, the supply curve for labor is vertical, which means that wages fall but employment does not change.
7.5 USING THE FULL-EMPLOYMENT MODEL
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
How an Adverse Technology Shock Affects Labor Demand and Supply
Real Business Cycle Theory
real business cycle theory
The economic theory that emphasizes how shocks to technology can cause fluctuations in economic activity.
An adverse shock to technology will decrease the demand for labor.
As a result, both real wages and employment fall as the market equilibrium moves from a to b.
7.5 USING THE FULL-EMPLOYMENT MODEL (cont.)
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
DO EUROPEAN SOCCER STARS CHANGE CLUBS TO REDUCE THEIR TAXES?
APPLYING THE CONCEPTS #2: What evidence is there that taxes on high paid soccer stars in Europe affect their location decisions among countries?
In 2009, a Portuguese soccer star moved from Manchester United in the United Kingdom to Real Madrid in Spain. Many speculated that the reason he moved was to avoid a top United Kingdom tax rate of 50 percent in favor of a flat 24 percent rate (with no deductions) created to entice foreigners to locate in Spain. While this is an interesting anecdote, is there any other evidence that the very top earners will move to countries with lower tax rates?
In an interesting study, economists Henrik Jacobsen Kleven, Camille Landais,and Emmanuel Saez used changes in the market for international soccer stars to test for the effects of tax rates. Prior to 1995, the top European soccer clubs had limits on the number of foreign players on any one team. The European Court of Justice, however, ruled that these limits violated the treaty of the European community. The economists found that prior to 1995, taxes on high earners did not have much effect on mobility of soccer stars, but after 1995, top tax rates did matter.
This type of evidence suggests that countries may not only be in competition for top athletes, but also for other highly paid individuals—from tennis players to corporate executives.
A P P L I C A T I O N
2
7-*
CAN LABOR MARKET POLICIES ACCOUNT FOR THE GREAT DEPRESSION?
APPLYING THE CONCEPTS #3: Can real business cycle models explain the origin and persistence of the Great Depression?
Real Business Cycle models do not explain the Great Depression
Economists Cole and Ohanian of UCLA modified the standard model to include other factors.
President Roosevelt’s New Deal allowed firms to collude if they recognized unions and raised wages.
President Hoover also had polices that raised wages.
Incorporating these factors into the model allow it to explain the origin and severity of the Great Depression.
A P P L I C A T I O N
3
7-*
DEMANDS FOR GDP AT FULL EMPLOYMENT
Copyright ©2014 Pearson Education, Inc. All rights reserved.
7-*
crowding out
The reduction in investment (or other component of GDP) caused by an increase in government spending.
P R I N C I P L E O F O P P O RT U N I T Y C O S T
The opportunity cost of something is what you sacrifice to get it.
closed economy
Y = C + I + G
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
FIGURE 7.8
Increased government spending crowds out consumption by consumers.
The vertical bar highlights the time period during which crowding out occurred.
SOURCE: U.S. Department of Commerce.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
FIGURE 7.9
U.S. Investment and Government Spending During World War II
Increased government spending also crowds out private investment spending.
The vertical bar highlights the time period during which crowding out occurred.
SOURCE: U.S. Department of Commerce.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
open economy
Crowding in
crowding in
The increase of investment (or other component of GDP) caused by a decrease in government spending.
Increased government spending need not crowd out either consumption or investment. It could lead to reduced exports and increased imports.
7.6 DIVIDING OUTPUT AMONG COMPETING
DEMANDS FOR GDP AT FULL EMPLOYMENT
(cont.)
7-*
classical models
closed economy
crowding in
crowding out
full-employment output