Lecture 5. Productivity, Output, Employment - Irfan Lalirfanlal.yolasite.com/resources/Chapter03...
Transcript of Lecture 5. Productivity, Output, Employment - Irfan Lalirfanlal.yolasite.com/resources/Chapter03...
Chapter 3
Productivity, Output, and
Employment
Introduction
• This chapter describes factors that
determine the level of output produced in
an economy.
• It also begins to develop our theory of the
economy.
Over the Next Few Chapters …
• Our strategy will be to develop theories for
– the labor market
– goods markets
– asset markets
• We argue markets in these sectors tend to
“equilibrate”
• We investigate what further implications
can be derived from the theory
Production
Production refers to the transformation of inputs
or resources into outputs of goods and services.
In other words, production refers to all of the
activities involved in the production of goods and
services, from borrowing to set up or expand
production facilities, to hiring workers,
purchasing raw materials, running quality
control, cost accounting, and so on, rather than
referring merely to the physical transformation of
inputs into outputs of goods and services.
For example
• A computer company hires workers to use
machinery, parts, and raw materials in factories
to produce personal computers.
• The output of a firm can either be a final
commodity or an intermediate product such as
computer and semiconductor respectively.
• The output can also be a service rather than a
good such as education, medicine, banking etc.
Production Functions in Economics
• In economics, a “production function" describes an empirical relationship between specified output and inputs. A production function can be used to represent output production for a single firm, for an industry, or for a nation. Just to illustrate, a production function of rice might have the form:
W=F(L,A,M,F,T,R)
• That is, production of rice (paddy) in tons (W) depends on the use of labor measured in days (L), land in acres (A), machinery in dollars (M), fertilizer in tons (F), mean summer temperature in degrees (T), and rainfall in inches (R).
Production Functions in Economics
• In most applications of production
functions, the input variables are simply
labor (L) and capital (C). The output is
usually measured by physical units
produced or, perhaps, by their value.
• Labor is typically measured in man-hours
or number of full-time-equivalent (FTE)
employees.
Long and short run production
function
• The short-run production function shows the
maximum quantity of good or service that can be
produced by a set of inputs, assuming the
amount of at least one of the inputs used
remains unchanged.
• The long-run production function shows the
maximum quantity of good or service that can be
produced by a set of inputs, assuming the firm is
free to vary the amount of all the inputs being
used.
The Production Function
• Output produced in an economy depends
on:
– The amounts of inputs available, for example
capital and labor, also raw materials
– The effectiveness with which these inputs are
used
The Production Function in
Equation Form
Empirical Production
Functions
Cobb-Douglas Production Function
Q = AKaL1-a
Estimation of Production Functions
Forms of Production Functions
– Cobb-Douglas Production Function
• Can be estimated by linear regression analysis
• Can accommodate any number of independent
variables
• Does not require that technology be held constant
• Shortcomings:
– Cannot show a firm or industry passing through
increasing, constant, and decreasing returns to scale
– Specification of data to be used in empirical estimates`
Estimation of Production Functions
• Statistical Estimation of Production
Functions
– Usually, the most important input is labor.
– Most difficult input variable is capital.
– Must choose between time series and cross-
sectional analysis
Estimation of Production Functions
• Aggregate Production Functions
– Many studies using Cobb-Douglas did not deal with individual firms, rather with aggregations of industries or an economy.
– Gathering data for aggregate functions can be difficult.
• For an economy: GDP could be used
• For an industry: data from Census of Manufactures or production index from Federal Reserve Board
• For labor: data from Bureau of Labor Statistics
A Production Function for the
U.S.
• The following production function
equation fits U.S. data well (See Table
3.1, next slide):
0.3 0.7Y AK N
Table 3.1 The Production Function of the
United States, 1979-2004
Production Function
Properties
• We normally plot output as a function of
one input, holding other inputs
conceptually fixed.
• The production function is upward sloping
(as we plot output versus an input, e.g.
capital).
• The production function becomes flatter as
we move from left to right (increasing labor
and output)
Figure 3.3 The production function relating
output and labor
Marginal Product of Labour and
Marginal Product of Capital
Marginal Product of Labour
Measure of the physical increase in the output of a firm or economy; it is the output that results from hiring one additional worker, all other factors remaining constant. Marginal Product of Capital
is the additional output resulting from the use of an additional unit of capital (ceteris paribus, or assuming all other factors are fixed).
Marginal Products
Useful properties
• Several Useful Properties :
• The Marginal Product of capital and the marginal Product of labor depend on both the quantity of capital and the quantity of labor used in production, as is often the case in the real world.
• K and L are represents the output elasticity of labor and capital and the sum of these gives the returns on scale.
• a + b = 1 Constant return to scale
• a + b > 1 Increasing return to scale
• a + b <1 Decreasing return to scale
Marginal Products
• There is a geometric interpretation of the marginal
product:
– The slope of the production function at a point (showing
output as a function of labor) is the marginal product of
labor:
• Properties of the production function, revisited:
– The marginal product of labor is positive.
– The marginal product of labor falls as the amount of labor
increases (holding the capital stock fixed).
Y
L
Figure 3.2 The marginal product of
capital
Diminishing Marginal Productivity
A decrease in how quickly the output of a
production process grows in response to
more of one input. Diminishing marginal
product is used to identify the point
of diminishing returns, at which adding more
of a material needed for production begins to
have less of a benefit to the output of the
process.
The Law of Diminishing Returns
As additional units of a variable input are
combined with a fixed input, after a point the
additional output (marginal product) starts to
diminish. This is the principle that after a
point, the marginal product of a variable input
declines.
The law of diminishing return
X
MP
Increasing Returns
Diminishing Returns Begins
MP
Example
If at one shop 1 person is working and if we employ 1 more person , then, total Productivity will increase at an increasing rate as they can have better division of labor now. Productivity will increase at an increasing rate till there are 6 workers and they are fully utilized. And if we will employ 1 more person then total productivity might increase, but the average productivity will fall, ie Productivity per person will fall due to 1 extra unit of labour. or we can say addition made by the 6th worker is less than the earlier unit (ie Marginal product of 6th unit of labour will fall.)
Example
Capital Input Labour Input Total Output Marginal Product Average Product of Labour
20 1 5 - 5
20 2 16 11 8
20 3 30 14 10
20 4 56 26 14
20 5 85 28 17
20 6 114 29 19
20 7 140 26 5
20 8 160 20 16
20 9 171 11 30
20 10 180 9 56
20 11 187 7 85
Stages Total Product
(TP)
Marginal Product
(MP)
Average
Product (AP)
Stage 1 Increases at an
increasing rate up to
point H later at
diminishing rate
Initially increases
and reaches the
maximum at point
G’ and after point
G’ begin to diminish
Increases and
reaches at its
maximum point
H’,which is at
the boundary
line of stage 1.
At point H AP
and MP are
equal
Stage 2 Continue to increase
at diminishing rate up
to point J and reaches
it maximum
Continues to
diminish and
becomes zero at
point J’
After reaching
its maximum it
begins to
diminish
Stage 3 Start declining Becomes negative Continue to
diminish but
always remain
greater than
zero
Supply Shocks
• Our production function shows that output
is a function of capital and labor inputs
• However, this function is subject to change
as a result of:
– Technological change
– Changes in regulatory environment
– Changes in the supply of inputs other than
capital and labor (e.g., energy)
Curve Shifts
• The production function is a multivariable
function
– Output depends on capital, labor, the
productivity parameter, and (implicitly) other
omitted variables
• So, if we plot output versus labor, we
conceptually hold the other variables fixed
– If any of those other variables change, our
plot of the production function must shift
Figure 3.4 An adverse supply
shock that lowers the MPN
The Labor Market
• We now consider the labor market
• We will now assume that capital is fixed (in
fact, the capital stock grows slowly over
time)
• In a typical business cycle, capital varies
little, but labor varies a lot
The Demand for Labor:
Assumptions
• The capital stock is fixed.
• Workers are all alike.
• Wages are determined in competitive
labor markets.
• Firms choose how much labor to employ
in order to maximize profit.
Profit Maximization and
Labor Demand
• A firm will hire an additional unit of labor
so long as the value of the extra output
produced by a worker is greater than (or
just equal to) the cost of the additional unit
of labor
Profit Maximization and
Labor Demand (Equations)
Notation
Profit Maximum
Summary
Demand for Labor
• At any given real wage, what quantity of
labor will a firm buy?
– Answer: The quantity that makes the marginal
product of labor equal the real wage.
The Demand for Labor
• The marginal product of labor and the
labor demand curve
– Labor demand curve shows relationship
between the real wage rate and the quantity
of labor demanded
– So the labor demand curve is downward
sloping; firms want to hire less labor, the
higher the real wage
Demand Shifters
• Factors that shift the labor demand curve
– Note: A change in the wage causes a
movement along the labor demand curve, not
a shift of the curve
– Supply shocks: Beneficial supply shock raises
MPN, so shifts labor demand curve to the
right; opposite for adverse supply shock
– Size of capital stock: Higher capital stock
raises MPN, so shifts labor demand curve to
the right; opposite for lower capital stock
The Supply of Labor
– The labor supply curve
• Increase in the current real wage should raise
quantity of labor supplied
• Labor supply curve relates quantity of labor
supplied to real wage
• Labor supply curve slopes upward because higher
wage encourages people to work more
The Supply of Labor
The Supply of Labor
• Factors that shift the labor supply curve
– Wealth: Higher wealth reduces labor supply
(shifts labor supply curve to the left,
– Expected future real wage: Higher expected
future real wage is like an increase in wealth,
so reduces labor supply (shifts labor supply
curve to the left)
The Supply of Labor
Labor Market Equilibrium
A Favorable Supply Shock
Effects of A Temporary
Adverse Supply Shock
Full Employment
• In the labor market, the demand-supply equilibrium determines the quantity of labor, the number employed. – We consider this to be the “full-employment” quantity
of labor.
• Also, if we use the production function to find the level of output produced when the labor input is at its full-employment level, we call that output the full-employment level of output:
,Y AF K N
Full Employment
• A situation in which all available labor resources
are being used in the most economically efficient
way. Full employment embodies the highest
amount of skilled and unskilled labor that could
be employed within an economy at any given
time. The remaining unemployment is frictional.
Labor Force: Each person over age 18 and below 60 is
considered as a Labor force in Pakistan
Households can assigned to one of three categories:
• Employed: If the person worked full time job or part time
job during the past week (or was on sick leave or
vacation from a job)
• Unemployed: If the person didn’t work during the past
week but looked for work during the past four weeks.
• Not in the Labor force: if the person didn't work during
the past week and didn't look for work during the past
four weeks (examples are full-time students age less
than 18, homemakers, and retirees).
Unemployment
• Long-run versus Short-run Unemployment: – Long-run: The natural rate of unemployment
– Short-run: The cyclical rate of unemployment
• Natural Rate of Unemployment – The amount of unemployment that the economy
normally experiences and does not go away on its own even in the long run.
• Cyclical Unemployment – Associated with with short-term ups and downs of the
business cycle and refers to the year-to-year fluctuations in unemployment around its natural rate
Types of Unemployment
• Frictional Unemployment
• Cyclical Unemployment
• Structural / Technological Unemployment
• Seasonal Unemployment
• Voluntary Unemployment
• Hidden Unemployment
Frictional Unemployment
• Frictional Unemployment - always some
unemployment due to workers voluntarily
changing employment
• Frictional unemployment – may reflect
acquisition of more skills and training. Duration
of unemployment depends on knowledge of
labour market and efficiency of job seeking.
Cyclical Unemployment
• Cyclical Unemployment or demand-
deficient unemployment occurs in the
downswing and recession phases of the
trade cycle.
• It is basically due to substantial reductions
in aggregate demand or total spending in
the economy.
Cyclical Unemployment
• The reduction in demand for goods and services
leads to a reduction in total output and ultimately
results in a reduction in demand for the labour
that produce those goods and services.
• Cyclical unemployment is considered serious by
governments of the world who are charged with
correcting flagging aggregate demand via
appropriate economic policy.
Structural / Technological
Unemployment
• Structural / Technological Unemployment refers to changes in the structure of the economy over time due to technology changes and changes in the pattern and nature of consumer spending.
• Technological change usually means that the demand for some types of workers increases, while others find their skills are no longer relevant
Structural / Technological
Unemployment
• Bank tellers under threat from automatic teller machines (ATM), the replacement of horse and carriage by the motor vehicle causing unemployment for blacksmiths are both examples of structural unemployment.
• Changes in consumer demand, will result in job losses in some occupations and gain in others. As compact discs replace records, for example, workers in records factories become redundant.
Seasonal Unemployment
• Seasonal Unemployment affects
occupations such as fruit pickers,
fishermen and shearers. Where the
nature of their work means that
employment may not be available for the
whole year.
Voluntary Unemployment
• Those able people who prefer for various
reasons to be without a job.
Hidden Unemployment
• Those people who have given up ‘actively
seeking work’ due to frustration, loss of
self esteem or despair – are more
commonly referred to as discouraged
workers or the hidden unemployed.
Okun's Law:
The quantitative impact on aggregate output of a
change in the unemployment rate is described by
Okun's law, a rule of thumb (rather than a "law") first
stated by Arthur Okun, chairman of the Council of
Economic Advisers in the 1960s during
the Johnson administration. According to Okun's law,
the gap between an economy's full-employment output
and its actual level of output increases by 2 percentage
points for each percentage point the unemployment rate
increases.20,21 We express Okun's law algebraically
as
Okun’s Law Statistics in Asian
Countries
Reasons for higher youth unemployment
Human capital: A number of students leave school or college with few
qualifications and therefore lack the human capital needed to find secure
employment
Experience: Younger workers have less experience in the labour market
and employers may decide to employ someone with a track record in work
that is perceived to be more productive. In recruitment freeze, younger
workers often miss out because of the experience factor.
Training costs: Some employers may not want to cover the extra costs of
training younger workers – preferring instead to take a free-ride on
employees who have received training in their previous job
Internships: There has been a decline in the number of internship
available for people leaving school aged 16. High quality vocational
education makes younger workers more employable.
Benefit reforms: Some economists believe that youth unemployment is
partly the result of the benefits system and that claiming benefit should be
made harder for those who have not taken paid work after leaving school
or college. For example, unemployment benefits could rise according to
how many years a person has been working and paying national
insurance