ECON 101B Chapter Notes - Chapter 6: Market Clearing, Marginal Product, Real Interest Rate
Chapter 6: Building Blocks of Flexible-Price Model
6.1: Potential Output and Real Wages
ā The production function
ā Potential output: the level at which national product would be if all resources
were fully employed
ā Production function: the relationship between the total amount of output produced
in an economy and the quantities of labor and capital and the levels of technology
and organization used to produce it
ā
ā K= capital stock
ā Y*= potential output
ā L= labor
ā E= efficiency of labor
ā Alpha (a)= parameter how fast returns to investment diminish
ā Assumption is that wages and prices are flexible = classical assumption
guarantees that markets work- that prices adjust rapidly to eliminate gaps between
the quantity demanded and the quantity supplied
issue
classical
Keynesian
Wages and prices
Fully flexible
Cna be āstickyā or fixed
expectations
Consistent with full
employment
Volatile -can take a number
of forms
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Labor market
Always in equilibrium with
full employment
Can eb out of equilibrium,
causing involuntary
unemployment
Effect of shocks to aggregate
demand
Change in the composition
but not the level of GDP
Change in the composition
and level of GDP
ā The labor market
ā When the supply of and demand for labor balance, real GDP will equal potential
output
ā Labor demand
ā Profits = revenues - costs
ā = (P*Y)-(W*L)
ā P= per unit price
ā Y= units of product
ā W= wage
ā L= workers
ā To figure how many workers to hire
ā Hire workers to boost output
ā Stop hiring when the extra revenue from the output
produced by the last worker hired just equal his/her wage
ā MPL = marginal product of labor firm will keep hiring until P*MPL - W =
0
ā
ā Labor market equilibrium
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Potential output: the level at which national product would be if all resources were fully employed. Production function: the relationship between the total amount of output produced in an economy and the quantities of labor and capital and the levels of technology and organization used to produce it. Alpha (a)= parameter how fast returns to investment diminish. Assumption is that wages and prices are flexible = classical assumption guarantees that markets work- that prices adjust rapidly to eliminate gaps between the quantity demanded and the quantity supplied issue classical. Can eb out of equilibrium, causing involuntary unemployment. Change in the composition but not the level of gdp. Change in the composition and level of gdp. When the supply of and demand for labor balance, real gdp will equal potential output. To figure how many workers to hire. Stop hiring when the extra revenue from the output.