Outline The Production Function The Demand for Labor The Supply of Labor Labor Market Equilibrium Unemployment Relating Output and Unemployment Okuns Law Interesting Questions If oil shocks hurt our economy should we look to alternate fuels If your salary went up permanently would you work more or less If you received a onetime increase to work extra hours would you Should minimum wage increase Are the recent increase the right increases The Production Function What goes into the production of output Factors of production Capital (K) Labor (N) Others (land, energy) Technology and management Our production function is going to be YAF(K,N) The parameter A is total factor productivity. Kinda like technology. There is a special form of the production function called Cobb-Douglas that actually shows a stable relationship for the U.S. economy. YAK.3N.7. We have no way of measuring A directly. It is found by solving the production function for A. Taking 2004 for example 10756(y)A11249.3139.3.7 Solving for A we get a productivity of 20.68. What does the production function look like Ok what do we know If we add more inputs then we get more output. But, the increase is going to keep getting smaller because of diminishing marginal product as inputs increase. Ex. Pizza Company. (Holding Workers Constant) EMBED Excel.Chart.8 s MPK is always positive Diminishing marginal productivity of capital says that MPK declines as K rises. We can make all of the same arguments for graphing output against labor holding ovens constant. EMBED Excel.Chart.8 s Number of WorkersNumber of Pizzas00110218324428530630730 What Shifts the Production Function Supply shocks Supply shock productivity shock a change in an economys production function Supply shocks affect the amount of output that can be produced for a given amount of inputs Shocks may be positive (increasing output) or negative (decreasing output) Examples weather, inventions and innovations, government regulations, oil prices Let us take a look at an adverse supply shock that will lower the MPN. Summary of supply shocks Supply shocks cause shifts in the production function. Negative shocks usually it is a shift down of the production curve and the slope of the production function decreases at each level of input. Positive shock usually it is a shift outward of the production curve and the slope of the production function will increase at each level of output. The Demand for Labor The question is really how much labor do firms want to use In order to get a meaningful answer we need to make some important assumptions Hold the capital stock fixed Short-run we dont buy new ovens or factories Workers are all alike If we look at a large segment of people in the same job area this is not such a bad assumption. Labor market is competitive Says that there is a prevailing wage set for a given job. i.e. all economists make 10/hr. Firms want to maximize their profits I think everyone can live with this assumption. Back to the Pizza example Ok let us assume each pizza sells for 20. MPNP is the Marginal Revenue product of labor. MRPN tells us how much additional revenue that one extra worker would bring to the pizza shop if he was hired. Number of WorkersNumber of PizzasMPNMPN P (MRPN)0010200 1108160 2186120 324480 428240 5300063000730 So how many workers is the pizza shop going to hire Let us say that the going nominal wage is 150 dollars. Well we can see that the pizza shop will make a profit if they hire the first worker (the worker is providing 200 of revenue and only costs 150) they will also hire the second worker for the same argument. But, they will not hire the third worker because that worker is only bringing an addition 120 of revenue but will cost 150. What happens if the prevailing nominal wage was to decrease to 110 Then they would hire the third worker. So in summary if the MRPN is higher than the prevailing nominal wage there is an incentive to hire additional workers, if