ECON 352-Chapter 2 Notes

Chapter 3 Notes
Productivity, Output, and Employment
●​ Physical side of economic activities: real economic variables
○​ Variables: production, real GDP, and unemployment
●​ Monetary side of economic activities: monetary activities that facilitate real economic
activities.
○​ Variables: money, nominal GDP, nominal interest rate
●​ Normal growth rate of GDP = 3%

Short-Fun Production Function:
→ Y = F(N)
-​ GDP = Y
-​ N = labor
-​ K = capital
●​ The labor market decides the optimum N*




●​ The law of diminishing returns: applies to any physical activity
●​ Demand shifters for labor (micro):
○​ Increase in productivity of labor
○​ Increase in capital
●​ Supply of labor:
○​ Individual utility maximizing choice of labor between income and leisure
○​ Individual utility: U = f(Leisure, Income)
■​ More leisure → less income
■​ Less leisure → more income
○​ Income effect: negative

, ■​ Increase in wages → less working hours → reduces supply of labor
■​ Decrease in wages → more working hours → raises supply of labor
○​ Substitution effect: positive
■​ Wage increases → leisure more expensive → more working hours
■​ Wage decreases → leisure less expensive → less working hours

Labor Market
●​ Demand shifters (macro):
○​ increase in productivity of labor
○​ Increase in capital
●​ Supply shifters (macro):
○​ Wealth
■​ Increase in wealth → decrease supply of labor
○​ Expectations of future wage
■​ Increase in expectation → decrease supply of labor
○​ Increase in working-age population
■​ Increase in supply of labor
○​ Increase in labor participation rate
■​ Increase in supply of labor

Wages and employment
●​ Demand for labor:
●​ Rational behavior: benefit >/= cost
○​ Corporate: MPL (marginal product of labor), wage
■​ MPL > w → hire
■​ MPL < w → fire
■​ MPL = w → optimal
●​ Marginal Revenue Product of Labor (MRPL) or Value of Marginal Product of Labor
(VMPL) = P*MPL
○​ VMPL > W​ Hire more labor
○​ VMPL < W​ Fire labor
○​ VMPL = W​ Profit-Maximizing, Equilibrium

Long-Run Production Function
→ Y = F(K, N)
-​ Y: output
-​ K: capital input
-​ N: labor input
●​ MPL/W > MPK/r : Hire more labor or reduce capital.
●​ MPL/W < MPK/r : Hire more capital or reduce labor.