Slide 1Slide 2The Economy at Full EmploymentWAGE AND PRICE FLEXIBILITY AND FULL EMPLOYMENTTHE PRODUCTION FUNCTIONSlide 6Slide 7Slide 8WAGES AND THE DEMAND AND SUPPLY FOR LABORSlide 10Slide 11Slide 12Slide 13LABOR MARKET EQUILIBRIUM AND FULL EMPLOYMENTUSING THE FULL-EMPLOYMENT MODELSlide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.1 of 23Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.2 of 23Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.3 of 23The Economy at Full EmploymentFERNANDO QUIJANO, YVONN QUIJANO, AND XIAO XUAN XUP R E P A R E D B YImmigration is an important part of the U.S. economy today.Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.4 of 24C H A P T E R 7The Economy atFull EmploymentWAGE AND PRICE FLEXIBILITYAND FULL EMPLOYMENT7.1● classical models Economic models that assume wages and prices adjust freely to changes in demand and supply.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.5 of 24C H A P T E R 7The Economy atFull EmploymentTHE PRODUCTION FUNCTION7.2•production functionThe relationship between the level of output of a good and the factors of production that are inputs to production.•stock of capitalThe total of all machines, equipment, and buildings in an entire economy.•laborHuman effort, including both physical and mental effort, used to produce goods and services.When there are only two factors of production, capital and labor, the production function is written as follows:Y = F(K,L)Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.6 of 24C H A P T E R 7The Economy atFull EmploymentTHE PRODUCTION FUNCTION7.2 FIGURE 7.1The Relationship between Labor and Output with Fixed CapitalWith capital fixed, output increases with labor input, but at a decreasing rate.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.7 of 24C H A P T E R 7The Economy atFull EmploymentTHE PRODUCTION FUNCTION7.2P 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 SSuppose 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.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.8 of 24C H A P T E R 7The Economy atFull EmploymentTHE PRODUCTION FUNCTION7.2 FIGURE 7.2An Increase in the Stock of CapitalWhen the capital increases from K1 to K2, the production function shifts up. At any level of labor input, the level of output increases.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.9 of 24C H A P T E R 7The Economy atFull EmploymentWAGES AND THE DEMAND ANDSUPPLY FOR LABOR7.3 FIGURE 7.3The Demand and Supply of Labor•real wageThe wage rate paid to employees adjusted for changes in the price level.Together, the demand and supply for labor determine the level of employment and the real wage.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.10 of 24C H A P T E R 7The Economy atFull EmploymentWAGES AND THE DEMAND ANDSUPPLY FOR LABOR7.3Labor Market EquilibriumPanel 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.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.11 of 24C H A P T E R 7The Economy atFull EmploymentWAGES AND THE DEMAND ANDSUPPLY FOR LABOR7.3 FIGURE 7.4Shifts in Labor Demand and SupplyChanges in Demand and SupplyM A R G I N A L P R I N C I P L EIncrease 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.Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. Macroeconomics: Principles, Applications, and Tools O’Sullivan, Sheffrin, Perez 6/e.12 of 24C H A P T E R 7The Economy atFull EmploymentIMMIGRATION AFFECTS BOTH THE DEMAND AND THE SUPPLY FOR LABORAPPLYING THE CONCEPTS #1: Although we normally think that increased immigration will reduce wages, what factors could cause it to raise wages?A recent study by Gianmarco Ottaviano of theUniversity of Bologna and Giovanni Peri of theUniversity of California, Davis, estimated that during the 1990s immigration, on average, increasedthe average wage of U.S.-born workers by 2.7 percent.They took into account that increased immigration led to increases in the supply of labor and additional investment, and as a result, both the demand and the supply for labor shifted, with the shift in demand slightly outpacing the shift in supply.When they looked more closely at wages, they found the wages of high-school dropouts fell, while wages of workers with at least a high-school education increased. The reason for this difference