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ES10002- Introduction to Macroeconomics > Topic 3 > Flashcards

Topic 3 Flashcards

1
Q

What are the factors of production?

A

Capital (K)
Labour (N)
Others (raw materials, land, energy etc)

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2
Q

What does the productivity of factors of production depend on?

A

Technology and management

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3
Q

What is the equation of the production function?

A

π‘Œ = 𝐴𝐹(𝐾, 𝑁)

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4
Q

What is parameter A in the productivity function?

A

Parameter 𝐴 represents the total factor productivity – a measure of the effectiveness with which capital and labour are used

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5
Q

What is the equation of the Cobb-Douglas production function?

A

π‘Œ = 𝐴𝐾^𝛼 x 𝑁^1βˆ’π›Ό

Where 𝛼 ∈ 0,1 (i.e., 0 < 𝛼 < 1)

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6
Q

What is the Cobb-Douglas production function characterised by?

A

This production function is characterised by Constant Returns to Scale (CRS)

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7
Q

What happens when you multiply the Cobb-Douglas production by lamda?

A

Total output is multiplied by lamda

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8
Q

What are the main two properties of the production function?

A

Slopes upward: more of any input produces more output

Slope becomes flatter as input rises: diminishing marginal product as input increases

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9
Q

What is on the axis of the production function?

A

Y-axis = Output, Y
X-axis= Capital, K

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10
Q

Consider π‘Œ = 𝐴𝐹(𝐾, 𝑁), how do you calculate the marginal product of capital (MPK)? (2)

A

𝑀𝑃𝐾 =Ξ”π‘Œ/Ξ”K

𝑀𝑃𝐾 = 𝐴 πœ•πΉ / πœ•K

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11
Q

What is the MPK equal to?

A

The slope of the production function

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12
Q

How do you represent the MPK as a function?

A

MPK(.) where the dot is in the middle and it represents an independent variable

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13
Q

What are the assumptions of MPK? (2)

A

𝑀𝑃𝐾 is always positive

𝑀𝑃𝐾 declines as 𝐾 increases (diminishing marginal productivity of capital)- upwards concave

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14
Q

Consider π‘Œ = 𝐴𝐹(𝐾, 𝑁), what is the marginal product of labour (MPL)? (2)

A

𝑀𝑃𝑁 =Ξ”π‘Œ / Ξ”N

𝑀𝑃𝑁 = 𝐴 πœ•πΉ / πœ•N

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15
Q

What is the MPN equal to?

A

𝑀𝑃𝑁 is equal to the slope of the production function graph

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16
Q

What are the assumptions of MPN? (2)

A

𝑀𝑃𝑁 is always positive

𝑀𝑃𝑁 declines as 𝑁 increases (diminishing marginal productivity of labour)

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17
Q

How do you calculate MPK using the Cobb-Douglas function?

A

Consider the production function π‘Œ = 𝐴𝐾^𝛼 x 𝑁^(1βˆ’a).

𝑀𝑃𝐾 =πœ•π‘Œ (βˆ™) / πœ•πΎ =
𝛼𝐴𝐾^ (π›Όβˆ’1) x 𝑁(^1βˆ’π›Ό)
= 𝛼𝐴 (𝑁 / 𝐾)^(1βˆ’π›Ό)

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18
Q

MPK = 𝛼𝐴 (𝑁 / 𝐾)^(1βˆ’π›Ό), what happens as K rises?

What happens when A rises?

What type of function is MPK in terms of N?

A

As K rises, MPK falls.

As A increases, MPK increases.

MPK is an increasing function of N.

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19
Q

How do you calculate MPN using the Cobb-Douglas function?

A

Consider the production function π‘Œ = 𝐴𝐾^𝛼 x 𝑁^(1βˆ’a).

𝑀𝑃N =πœ•π‘Œ (βˆ™) / πœ•N =
(1 - 𝛼)A(K / N)^𝛼

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20
Q

MPN= (1 - 𝛼)A(K / N)^𝛼, what happens as N rises?

What happens as K rises?

What happens as A rises?

A

As N rises, MPN falls.

As K rises and 𝑲/𝑡 is higher, MPN also rises.

As A rises, MPN increases.

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21
Q

What is a supply shock?

A

A change in an economy’s production function

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22
Q

What do supply shocks affect?

A

Supply shocks affect the amount of output that can be produced for given quantities of capital and labour

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23
Q

What is a positive supply shock?

A

The economy produces more output (Y) for given quantities of capital (K) and labour (N).

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24
Q

What is a negative supply shock?

A

The economy produces less output (Y) for given quantities of capital (K) and labour (N)

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25
Q

What are some examples of supply shocks?

A

Look at slides, or textbook.

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26
Q

How do we model supply shocks?

A

Through changes in the value of the productivity parameter A

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27
Q

What will a positive and negative supply shock do to parameter A?

A

A positive supply shock will always increase the value of productive parameter A

A negative supply shock will mean a decrease in the value of A

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28
Q

What do we assume that a positive supply shock will do to both MPK and MPN?

A

A positive supply shock will increase the values of both MPK and MPN

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29
Q

What do we assume that a negative supply shock will do to both MPK and MPN?

A

A negative supply shock will decrease the values of both MPK and MPN

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30
Q

How does the slope of the production function change from a positive supply shock?

A

The slope of the production function increases at each level of output

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31
Q

How does the slope of the production function change for a negative supply shock?

A

The slope of the production function decreases at each level of input

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32
Q

What are the assumptions of the labour markets on a micro level? (4)

A

Hold capital stock fixed (short-run & medium-run analysis)*

Workers and firms are alike

Labor market is competitive (Classical approach)

Firms maximize profits

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33
Q

How do we sometimes represent the production function in the SR, when capital stock is fixed?

A

The K has a bar on top

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34
Q

What is the short-run time horizon?

A

The time period during which aggregate output and employment can change but before prices and wages respond to the changes in economy-wide output and employment levels

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35
Q

What does not adjust to macroeconomic conditions and policies in the short-run?

A

The economy’s price level (𝑃) and (nominal or real) wage rate

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36
Q

What is meant by real wage rigidity?

A

The idea that the real wage rate moves β€œtoo little” in response to conditions in the aggregate labour market

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37
Q

What is price stickiness?

A

The tendency of prices to respond only slowly to
changes in the economy

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38
Q

What is the medium-run time horizon?

A

The time period during which prices and wages can respond to changes in aggregate output and employment

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39
Q

What do we continue to assume in the medium-run?

A

We continue to assume (as for the short-run) that the economy’s capital stock (𝐾) and labour force
(𝑁𝐹) are fixed

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40
Q

What do we not investigate in the MR?

A

We do not investigate changes in the population growth rate or allow for migration- belongs in the LR.

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41
Q

In the MR, what can we investigate?

A

The consequences of changes in technology- exogenous

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42
Q

To investigate the causes of productivity growth (endogenous) and why it might change, what time horizon do we need analyse?

A

The LR

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43
Q

In LR analysis, what do we allow for the analysis of?

A

We allow for growth in the population, in the physical capital stock (𝐾), human capital stock (skills of workers), and improvements in technology

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44
Q

What is a firm’s profit function?

A

Ξ  = 𝑝 Γ— π‘Œ (βˆ™) βˆ’ π‘Š Γ— N

p= price
W= wage

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45
Q

What is the optimality condition?

A

πœ•Ξ  / πœ•π‘ = 𝑝 Γ— [πœ•π‘Œ (βˆ™) / πœ•π‘] βˆ’ π‘Š = 0

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46
Q

At a given π‘Š level, the quantity of labour demanded is given by what?

A

p x MPN(.) = 𝑝 Γ— πœ•π‘Œ / πœ•π‘ = W

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47
Q

𝑝 Γ— πœ•π‘Œ (βˆ™) / πœ•π‘ = p x MPN(.) , what does this equation equal?

A

The marginal revenue product of labour (MRPN)

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48
Q

According to the optimality condition, what is the MPN(βˆ™) equal to?

A

Real wage rate

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49
Q

Suppose that at a given π‘Š level, 𝑀𝑅𝑃𝑁 (βˆ™) > π‘Š or 𝑀𝑃𝑁 (βˆ™) > 𝑀, what is the optimal course of action?

A

To increase the quantity of labour demanded =

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50
Q

Suppose that at a given π‘Š level, 𝑀𝑅𝑃𝑁 (βˆ™) < π‘Š or 𝑀𝑃𝑁 (βˆ™) < w, what is the optimal course of action?

A

To reduce the quantity of labour demanded

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51
Q

What does the labour demand curve show the relationship of?

A

Shows the relationship between the real wage rate and quantity of labour demanded

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52
Q

What is the labour demand curve the same as, and why?

A

It is the same as the 𝑀𝑃𝑁 curve, since 𝑀 = 𝑀𝑃𝑁 at equilibrium

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53
Q

Why is the labour demand curve downward sloping?

A

Firms want to hire less labor, the higher the real wage

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54
Q

In real terms, when should a firm increase or decrease employment?

A

Increase when 𝑀𝑃𝑁 > w.

Decrease when 𝑀𝑃𝑁 < w

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55
Q

In nominal terms, when should a firm increase or decrease employment?

A

Increase when 𝑝 Γ— 𝑀𝑃𝑁 > W

Decrease when 𝑝 Γ— 𝑀𝑃𝑁 < W

56
Q

On a diagram, what do we denote the beginning equilibrium where MPN=w?

A

NDo

57
Q

What happens when there is a rise in real wage rate?

A

Means that at 𝑁𝐷o, we now have: 𝑀𝑃𝑁 < w.
Amount of labour demanded falls.

58
Q

How is a rise in MPN, all else equal, shown on a diagram?

A

Shift outward of labour demand curve (ND)

59
Q

What does a rise in MPN mean in terms of a diagram ?

A

Means that at NDo, MPN > w.
So, the amount of labour demanded rises.

60
Q

What does a beneficial supply shock do to MPN?

A

A beneficial supply shock raises MPN, so it shifts the labor demand curve to the right; the opposite for an adverse supply shock

61
Q

Why does the size of capital stock shift the labour demand curve?

A

A higher capital stock raises MPN, so shifts the labor demand curve to the right; the opposite for a lower capital stock

62
Q

What does a change in the nominal or real wage cause on a diagram in terms of the demand curve?

A

Causes a movement along the labour demand curve

63
Q

What is the aggregate labour demand (ND)?

A

The sum of all firms’ labour demand

64
Q

What factors shift the aggregate labour demand curve? (2)

A

Productivity
Capital stock

65
Q

How can we express the aggregate labour demand function?

A

𝑁𝐷 = 𝑁𝐷 (𝑀; 𝐴,𝐾,Ξ©)

w = real wage rate
A= supply shocks
K= size of economy’s capital stock
Ξ©= composite variable (every other variable that could have an effect)

66
Q

What denotes real wage and nominal wage?

A

Real wage = w
Nominal wage = W

67
Q

How do you measure the real wage?

A

w = W / Price of output

68
Q

What is individual labour supply derived from?

A

Individual labour supply is derived from the optimizing behavior of households as they
allocate their time between work and leisure to maximize their utility

69
Q

What is the individual utility function?

A

U = U(c,L)

c= consumption
L= leisure

70
Q

What do we assume for the marginal utilities of consumption and leisure?

A

We assume that πœ•π‘ˆ (βˆ™)/ πœ•π‘ > 0 and
πœ•π‘ˆ (βˆ™) /πœ•πΏ > 0

71
Q

What is the constraint for an individual when deciding how to offer their labour?

A

Time constraint (T) (24 hours)
π‘€π‘œπ‘Ÿπ‘˜ π‘‘π‘–π‘šπ‘’ + π‘™π‘’π‘–π‘ π‘’π‘Ÿπ‘’ π‘‘π‘–π‘šπ‘’ = T

72
Q

What is the income leisure tarde off?

A

Compare the costs and benefits of working another day

73
Q

How should we decide how much labour to offer?

A

If the benefit of working another day exceeds the cost, work another day. Keep increasing labour time until benefits equal costs.

74
Q

What are the costs and benefits of the income-leisure trade off?

A

Cost: Loss of leisure
Benefit: More consumption, since labour income is higher

75
Q

What is the substitution effect?

A

Higher real wage encourages work, since the opportunity cost of leisure is higher

76
Q

How do you know the opportunity cost of leisure?

A

It is the real wage rate

77
Q

How does an increase in the real wage create the substitution effect?

A

𝑆𝐸: ↑ 𝑀 β‡’ ↓ π‘™π‘’π‘–π‘ π‘’π‘Ÿπ‘’ β‡’ ↑ π‘€π‘œπ‘Ÿπ‘˜ π‘‘π‘–π‘še

78
Q

What is the income effect?

A

Higher real wage increases income for the same amount of work time, so the person can afford more leisure. Thus, she will supply less labor

79
Q

What type of good is leisure?

A

A normal good

80
Q

How does an increase in the real wage create the income effect?

A

𝐼𝐸: ↑ 𝑀 β‡’ ↑ π‘™π‘’π‘–π‘ π‘’π‘Ÿπ‘’ β‡’ ↓ π‘€π‘œπ‘Ÿπ‘˜ π‘‘π‘–π‘še

81
Q

What is a pure substitution effect?

A

A one-day rise in the (current) real wage. The effect on the
(present value of expected future) wealth or lifetime income is negligible

82
Q

The bigger the change in lifetime resources the….

A

Stronger the income effect

83
Q

What are lifetime resources?

A

Wealth (πœ”, defined as assets – liabilities) + expected future wealth (πœ”^e) + lifetime labour income (determined by the current real wage rate, 𝑀 and the expected future real
wage rate, (𝑀^𝑒)

84
Q

What would a temporary real wage increase lead to?

A

A fall in leisure and an increase in work time- substitution effect dominates the income effect

85
Q

What is the pure income effect?

A

An increase in wealth

86
Q

Why doesn’t and increase in wealth have a substitution effect?

A

Because it doesn’t affect the price of
leisure

87
Q

How does an income in wealth create the pure income effect?

A

But winning the lottery makes a person wealthier, so a person will both consume more goods and take more leisure; this is a pure income effect

88
Q

Other than wealth, what can cause a pure income effect?

A

An increase in the expected future real wage

89
Q

Why does an increase in the expected future real wage not cause a substitution effect?

A

Because the current wage does not change, there is no effect on the price of leisure and there is no substitution effect on current labour supply

90
Q

For a long-term increase in real wage, what effect gets stronger with time?

A

The income effect

91
Q

What will a long-term increase in real wage cause in the labour supply compared to a temporary change?

A

Labor supply will increase by less (or decrease by more if income effect dominates) compared to the case of a temporary increase in the real wage

92
Q

What is the overall result of an increase in the temporary real wage?

A

Labor supply increases with a temporary rise in the real wage
(substitution effect dominates)

93
Q

What is the overall result of an increase in the permenant real wage?

A

Labor supply falls with a permanent increase in the real wage (income effect dominates).

94
Q

Why does the labour supply curve slope upwards?

A

Because a higher current real wage rate (holding constant the expected future real wage) encourages people to work more (substitution effect dominates)

95
Q

What denotes the labour supple curve?

A

NS

96
Q

How does an increase in the expected real wage rate effect the labour supply curve?

A

Shifts NS to the left

97
Q

What two factors shift the labour supply curve?

A

Wealth
Expected future real wage

98
Q

How does wealth shift NS?

A

Higher wealth reduces labour supply

99
Q

When does the aggregate labour supply rise?

A

When the current real wage rises (movement along the labour supply curve)

100
Q

What effect causes people to enter the labour force?

A

Substitution effect

101
Q

What factors increase aggregate labour supply? (4)

A

Decrease in wealth

Decrease in expected future real wage rate

Increase in working-age population (higher birth rate, immigration)

Increase in labour-force participation rate (increased female labour participation, elimination of mandatory retirement)

102
Q

What is the participation rate?

A

% of adult population in the labour force

103
Q

How do you denote labour market equilibrium?

A

the real wage 𝑀 bar and employment 𝑁 bar

104
Q

For Classicists, what happens when there is a temporary deviation from equilibrium?

A

Assumed to be eliminated by a movement in real wages. The real wage rate adjusts quite quickly to bring the market to equilibrium

105
Q

What is reached at the labour market equilibrium?

A

Full level of employment (Nbar)

106
Q

What type of unemployment is not present in a competitive labour market (Classical)?

A

Involuntary

107
Q

How do you denote the labour force?

A

NF

108
Q

What does labour market equilibrium look like on a diagram?

A

Look at slides and watch back lecture

109
Q

What is the function that shows full employment level of output (π‘Œbar)?

A

Ybar = AF(K, Nbar)

Nbar= full employment level

110
Q

What type of unemployment is shown by excess supply (Classical) ?

A

Involuntary

111
Q

What is the market said to be when equilibrium is reached?

A

Cleared

112
Q

How does a temporary adverse supply shock that lowers the MPN affect A?

A

Lowers output directly by reducing the amount of output that can be produced with any fixed amounts of capital and labour. This direct effect can be thought of as a reduction in 𝐴.h

113
Q

How does a temporary adverse supply shock that lowers the MPN affect the ND?

A

Reduces the demand for labour, 𝑁𝐷, and thus lowers the full-employment level of employment

114
Q

How does a temporary adverse supply shock that lowers the MPN affect the NS?

A

We assume that a temporary supply shock does not cause a shift of the labour supply
curve (𝑁S)

115
Q

Define the labour force.

A

Those who are able to have a job and want to have one

116
Q

What is the adult population?

A

Over 16

𝐴𝑑𝑒𝑙𝑑 π‘π‘œπ‘π‘’π‘™π‘Žπ‘‘π‘–π‘œπ‘› = πΏπ‘Žπ‘π‘œπ‘’π‘Ÿ π‘“π‘œπ‘Ÿπ‘π‘’ + π‘π‘œπ‘‘ 𝑖𝑛 πΏπ‘Žπ‘π‘œπ‘’π‘Ÿ π‘“π‘œπ‘Ÿπ‘e

117
Q

Who are discouraged workers?

A

People who have become so discouraged by lack of success at
finding a job that they stop searching β†’ Not in the labour force

118
Q

How do you measure the unemployment rate (u)?

A

No. of unemployed / Labour force

(NF - E) / NF
U / NF

119
Q

How do you measure the participation rate?

A

Labour force / Adult population

(E + U) / Pop
NF / Pop

120
Q

How do you measure the employment ratio?

A

Employed / Adult population

(NF - U) / Pop
E / Pop

121
Q

What type of unemployment always exist?

What do they prevent?

A

Frictional and structural unemployment

Prevent the unemployment rate from ever reaching zero- still present at equilibrium

122
Q

What is frictional unemployment? (2)

A

The unemployment that arises as individuals search for suitable jobs and firms search for suitable workers.

Joblessness experienced by people who are entering the labour force for the first time or after an absence

123
Q

Why is there always frictional unemployment?

A

Because jobs are continually being created and destroyed and workers continually enter and exit the labour force

123
Q

Is frictional unemployment present in the short-term of the long-term?

A

Usually the short-term

124
Q

What is structural unemployment?

A

Unemployment arising from mismatches (a) between workers’ skills and employers’ requirements, or (b) between workers’ locations and employers’ locations

125
Q

Why does structural unemployment arise?

A

Arises from structural changes in the economy: when old, dying industries are replaced with new ones that require different skills and are located in different areas of the country

126
Q

Is structural unemployment generally long term of short term?

A

Long term

127
Q

Who are the chronically unemployed (classified under structural unemployment)?

A

Workers who are unemployed a large part of the time. Usually, the lack of skills prevents them from finding long-term employment

128
Q

What is cyclical unemployment?

A

The unemployment that is caused by the business cycle

129
Q

What is cyclical unemployment a problem for?

A

Deciding on macroeconomic policy

130
Q

When do macroeconomists say that full employment has been reached?

A

When cyclical unemployment is reduced to zero, even though substantial amounts of frictional & structural unemployment may remain

131
Q

What is the natural rate of unemployment (u bar)?

A

The unemployment rate when output and employment are at full-employment levels

132
Q

What is the natural rate of unemployment equal to?

A

The frictional and structural unemployment

133
Q

What percentage of the unemployment rate is said to be due to frictional and structural unemployment?

A

4.5-5%

134
Q

What is said to be present if the unemployment rate is above 5%?

A

Cyclical unemployment

135
Q

How do you calculate cyclical unemployment?

A

Difference between the actual and the natural rate of unemployment:

𝒖𝒄 = 𝒖 βˆ’ 𝒖n

ES10002- Introduction to Macroeconomics (11 decks)

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