Econ214 macroeconomics Chapter 7
- 1. Chapter 7 The Economy at Full Employment
- 2. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-2 Learning Objectives • Identify the key assumption of classical models in macroeconomics. • 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.
- 3. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-3 ● 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
- 4. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-4 • 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. 7.2 THE PRODUCTION FUNCTION
- 5. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-5 FIGURE 7.1 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.)
- 6. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-6 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.)
- 7. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-7 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.)
- 8. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-8 FIGURE 7.4 Shifts in Labor Demand and Supply 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.)
- 9. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-9 Crowding Out in a Closed Economy • 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 An economy without international trade. output = consumption + investment + government purchases Y = C + I + G 7.6 DIVIDING OUTPUT AMONG COMPETING DEMANDS FOR GDP AT FULL EMPLOYMENT (cont.)
- 10. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-10 Crowding Out in a Closed Economy FIGURE 7.8 U.S. Consumption and Government Spending During World War II 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.)
- 11. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-11 Crowding Out in an Open Economy • open economy An economy with international trade. Y = C + I + G + NX 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.)
- 12. Copyright ©2014 Pearson Education, Inc. All rights reserved. 7-12 K E Y T E R M S classical models closed economy crowding in crowding out full-employment output labor open economy production function real business cycle theory real wage stock of capital