Chapter 3Chapter OutlineThe Production FunctionSlide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Figure 3.4 An adverse supply shock that lowers the MPNThe Demand for LaborSlide 19Table 3.2 The Clip Joint’s Production FunctionSlide 21Slide 22Figure 3.5 The determination of labor demandSlide 24Slide 25The Demand for LaborTable 3.3 The Clip Joint’s Production Function After a Beneficial Productivity ShockSlide 28Figure 3.6 The effect of a beneficial supply shock on labor demandSlide 30The Supply of LaborSlide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Figure 3.7 The labor supply curve of an individual workerSlide 40Figure 3.8 The effect on labor supply of an increase in wealthSlide 42Slide 43Slide 44The Supply of LaborSlide 46Slide 47Slide 48Slide 49Labor Market EquilibriumFigure 3.10 Labor market equilibriumSlide 52Slide 53Figure 3.11 Effects of a temporary adverse supply shock on the labor marketLabor Market EquilibriumSlide 56Slide 57Slide 58Slide 59Figure 3.13 The effects of skill-biased technical change on wage inequalityUnemploymentSlide 62Slide 63Slide 64Slide 65Slide 66Slide 67Slide 68Slide 69Slide 70Relating Output and Unemployment: Okun’s LawSlide 72Slide 73Slide 74Key Diagram 1 The production functionKey Diagram 2 The labor market© 2008 Pearson Addison-Wesley. All rights reservedProductivity, Output, and EmploymentChapter 3© 2008 Pearson Addison-Wesley. All rights reserved3-2Chapter Outline•The Production Function •The Demand for Labor•The Supply of Labor•Labor Market Equilibrium •Unemployment•Relating Output and Unemployment: Okun’s Law© 2008 Pearson Addison-Wesley. All rights reserved3-3The Production Function •Factors of production–Capital (K)–Labor (N)–Others (raw materials, land, energy)–Productivity of factors depends on technology and management© 2008 Pearson Addison-Wesley. All rights reserved3-4The Production Function •The production functionY = AF(K, N) (3.1)–Parameter A is “total factor productivity” (the effectiveness with which capital and labor are used)© 2008 Pearson Addison-Wesley. All rights reserved3-5The Production Function •Application: The production function of the U.S. economy and U.S. productivity growth–Cobb-Douglas production function works well for U.S. economy:Y = A K0.3 N0.7 (3.2)–Data for U.S. economy—Table 3.1© 2008 Pearson Addison-Wesley. All rights reserved3-6Table 3.1 The Production Function of the United States, 1979-2004© 2008 Pearson Addison-Wesley. All rights reserved3-7The Production Function •Productivity growth calculated using production function–Productivity moves sharply from year to year–Productivity grew slowly in the 1980s and the first half of the 1990s, but increased in the second half of the 1990s© 2008 Pearson Addison-Wesley. All rights reserved3-8The Production Function •The shape of the production function–Two main properties of production functions•Slopes upward: more of any input produces more output•Slope becomes flatter as input rises: diminishing marginal product as input increases© 2008 Pearson Addison-Wesley. All rights reserved3-9The Production Function •The shape of the production function–Graph production function (Y vs. one input; hold other input and A fixed)–Figure 3.1© 2008 Pearson Addison-Wesley. All rights reserved3-10Figure 3.1 The Production Function Relating Output and Capital© 2008 Pearson Addison-Wesley. All rights reserved3-11The Production Function •The shape of the production function–Marginal product of capital, MPK = Y/K Figure 3.2 = Key Diagram 1•Equal to slope of production function graph (Y vs. K)•MPK always positive•Diminishing marginal productivity of capitalMPK declines as K rises© 2008 Pearson Addison-Wesley. All rights reserved3-12Figure 3.2 The marginal product of capital© 2008 Pearson Addison-Wesley. All rights reserved3-13The Production Function •The shape of the production function–Marginal product of labor, MPN = Y/N Figure 3.3•Equal to slope of production function graph (Y vs. N)•MPN always positive•Diminishing marginal productivity of labor© 2008 Pearson Addison-Wesley. All rights reserved3-14Figure 3.3 The production function relating output and labor© 2008 Pearson Addison-Wesley. All rights reserved3-15The Production Function •Supply shocks–Supply shock = productivity shock = a change in an economy’s 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© 2008 Pearson Addison-Wesley. All rights reserved3-16The Production Function •Supply shocks–Supply shocks shift graph of production function (Fig. 3.4)•Negative (adverse) shock: Usually slope of production function decreases at each level of input (for example, if shock causes parameter A to decline)•Positive shock: Usually slope of production function increases at each level of output (for example, if parameter A increases)© 2008 Pearson Addison-Wesley. All rights reserved3-17Figure 3.4 An adverse supply shock that lowers the MPN© 2008 Pearson Addison-Wesley. All rights reserved3-18The Demand for Labor •How much labor do firms want to use?–Assumptions•Hold capital stock fixed—short-run analysis•Workers are all alike•Labor market is competitive•Firms maximize profits© 2008 Pearson Addison-Wesley. All rights reserved3-19The Demand for Labor •The marginal product of labor and labor demand: an example–Example: The Clip Joint—setting the nominal wage equal to the marginal revenue product of laborMRPN = P  MPN (3.3)–W = MRPN is the same condition as w = MPN, since W = P  w and MRPN = P  MPN© 2008 Pearson Addison-Wesley. All rights reserved3-20Table 3.2 The Clip Joint’s Production Function© 2008 Pearson Addison-Wesley. All rights reserved3-21The Demand for Labor •The marginal product of labor and labor demand: an example–A change in the wage•Begin at equilibrium where W = MRPN•A rise in the wage rate means W  MRPN, unless N is reduced so the MRPN rises•A decline in the wage rate means W  MRPN, unless N rises so the MRPN falls© 2008 Pearson Addison-Wesley. All rights reserved3-22The Demand for Labor •How much labor do firms want to use?–Analysis at the margin: