14-1Productivity, Output, and Employment, Part 24-2Agenda• The Supply of Labor• Labor Market Equilibrium • Unemployment• Okun’s Law 4-3The Supply of Labor • Supply of labor is determined by individuals:¾ Aggregate labor supply is the sum of individuals’labor supply.¾ The labor supply of individuals depends on their labor-leisure choices.4-4The Supply of Labor • The income-leisure trade-off:¾ Utility depends on consumption and leisure.¾ Compare costs & benefits of working another day.• Costs: Loss of leisure time.• Benefits: More consumption because of higher income.¾ Utility maximizing individuals will:• Work another day if the benefits exceed the costs and• Keep working additional days until benefits equal costs.24-5The Supply of Labor • Real wages and labor supply:¾ An increase in the real wage has 2 effects:• A substitution effect: A higher real wage increases the reward for working is higher so morelabor is supplied.• An income effect: A higher real wage increases income for same amount of work time so a person can afford more leisure and will supply lesslabor.4-6The Supply of Labor • Real wages and labor supply:¾ A pure substitution effect: a one-day rise in the real wage.• A temporary real wage increase has a pure substitution effect because the effect on wealth is negligible.• Consequently, an increasein labor supply.4-7The Supply of Labor • Real wages and labor supply:¾ A pure income effect: winning the lottery.• Winning the lottery doesn’t have a substitution effect, because it doesn’t affect the reward for working.• But it makes a person wealthier, so a person will both consume more goods and take more leisure. • Consequently, a reductionin labor supply.4-8The Supply of Labor • Real wages and labor supply:¾ The substitution effect and the income effect together: a long-term increase in the real wage.• The reward to working is greater so there is a substitution effecttoward more work.• With higher wage, a person doesn’t need to work as much to consume the same basket of goods and services so there is an income effecttoward less work.34-9The Supply of Labor • Real wages and labor supply:¾ The substitution effect and the income effect together: a long-term increase in the real wage.• The longer the high wage is expected to last, the stronger the income effect.• Thus labor supply will increase by less (or decrease by more) than for a temporary reduction in the real wage 4-10The Supply of Labor • Real wages and labor supply:¾ Labor supply increases with a temporary rise in the real wage.¾ Labor supply decreases with a permanentrise in the real wage. 4-11The Supply of Labor • Real wages and labor supply:¾ The labor supply curve, NS, relates the quantity of labor supplied to the current real wage.• Increases in the current real wage raise the quantity of labor supplied. – Some people work more hours.– Other people enter the labor force.• The labor supply curve slopes upward.4-12The Labor Supply CurveNw44-13The Supply of Labor • Factors that shift the labor supply curve:¾ Wealth: Higher wealth reduces labor supply, i.e., shifts the labor supply curve to the left.¾ Expected future real wage: Higher expected future real wage is like an increase in wealth and reduceslabor supply, i.e., shifts the labor supply curve to the left.4-14The Supply of Labor • Factors that shift the labor supply curve:¾ Working–age Population: A rise in the working-age population increaseslabor supply, i.e., shifts the labor supply curve to the right.¾ Labor force participation rate: A rise in the labor force participation rate also increaseslabor supply, i.e., shifts the labor supply curve to the right.4-15An increase in wealth on labor supplyNwNS04-16Labor Market Equilibrium • The labor market will be in equilibrium when labor supply equals labor demand. ¾ Determines the full-employment level of employ-ment, N, and the market-clearing real wage, w.54-17Labor Market EquilibriumNw4-18Labor Market Equilibrium • Full-employment output:¾ Full-employment output is the level of output when the labor market is in equilibrium.• Also called potential output.Y = AF(K, N)4-19Full-Employment OutputNYY=A0F(K0, N)4-20Labor Market Equilibrium • Factors that change full-employment output:¾ Shifts in the demand for labor and/or supply of labor that affects the full-employment level of employment.¾ Shifts in the production function from supply or productivity shocks.• Which will also shift the demand for labor.64-21Adverse Supply Shock and Labor MarketNwNSNDwN4-22Adverse Supply Shock & Production FunctionNYY=A0F(K0, N)NY4-23Unemployment • Measuring unemployment:¾ Three Categories: • Employed, • Unemployed, or• Not in the labor force.¾ Labor Force = Employed + Unemployed4-24Unemployment • Measuring unemployment:¾ Unemployment Rate = Unemployed/Labor Force¾ Participation Rate = Labor Force/Adult Population¾ Employment Ratio = Employed/Adult Population74-25Status of the U.S. Adult Population, May 20064-26Unemployment • Changes in employment status:¾ Flows between categories.• Discouraged workers are people who have become so discouraged by lack of success at finding a job that they stop searching.– They are in “not in the labor force.”4-27Average monthly changes in employment status4-28Unemployment • How long are people unemployed?¾ Most unemployment spells are of short duration.•An unemployment spell is the period of time an individual is continuously unemployed.• Duration is the length of an unemployment spell.¾ However, on any given date, most unemployed people are experiencing unemployment spells of long duration.84-29Unemployment • How long are people unemployed? Example:¾ Labor force = 100.¾ On the first day of every month, 2 workers become unemployed for one month each. ¾ On the first day of every year, 4 workers become unemployed for one year each.4-30Unemployment • How long are people unemployed? Example:¾ 28 spells of unemployment during a year.• 24 short spells of one month each and • 4 long spells of one year each.¾ Most spells of unemployment are short.4-31Unemployment • How long are people unemployed? Example:¾ On any given date, 6 people will be unemployed.• 4 have long spells of one year each.• 2 have short spells of one month each.¾ Most unemployed people on a given date have long spells of unemployment.4-32Unemployment • Why there are