After a careful analysis company Z has found out that they have revenue
loss about 30% compared to the previous year. They want to find out what
could be the cause as they have not changed their strategies that seemed to
be profitable in the past. They also would like to project about their likely profit
for the coming year.
They hire you as a consultant- manager. Utilizing the concepts covered in
this module, prepare a report that could explain some of the losses that might
be attributable to the general economic conditions in the country and some
factors that are business specific. What would be some of the leading
indicators/ coincident indexes that you would consider to help explain the
revenue loss and to project for the future profits? As a manager what would
be your recommendation to tackle with these problems?
Follow APA guidelines for the font, format, references etc.
Chapter 3
Productivity,
Output, and
Employment
Chapter Outline
•
•
•
•
•
•
The Production Function
The Demand for Labor
The Supply of Labor
Labor Market Equilibrium
Unemployment
Relating Output and Unemployment: Okun’s Law
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3-2
The Production Function
• Factors of production
–
–
–
–
Capital (K)
Labor (N)
Others (raw materials, land, energy)
Productivity of factors depends on technology
and management
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3-3
The Production Function
• The production function
Y = AF(K, N)
(3.1)
– Parameter A is “total factor productivity” (the
effectiveness with which capital and labor are
used)
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3-4
The 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
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3-5
Table 3.1: The Production Function of the
United States, 1991–2013
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3-6
The Production Function
• Productivity growth calculated using
production function
– Productivity moves sharply from year to year
– Productivity grew rapidly in the second half of
the 1990s, but grew more slowly in the 2000s
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3-7
The 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
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3-8
The Production Function
• The shape of the production function
– Graph production function (Y vs. one input; hold
other input and A fixed)
– Figure 3.1
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3-9
Figure 3.1: The production function
relating output and capital
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3-10
The 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 capital
MPK declines as K rises
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3-11
Figure 3.2: The marginal product of
capital
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3-12
The 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
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3-13
Figure 3.3: The
production
function relating
output and labor
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3-14
The 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
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3-15
The 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 (e.g., if shock
causes parameter A to decline)
• Positive shock: Usually slope of production function
increases at each level of output (e.g., if parameter A
increases)
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3-16
Figure 3.4: An adverse supply shock that
lowers the MPN
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3-17
The 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
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3-18
The 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
labor
MRPN = P 3 MPN
(3.3)
– W = MRPN is the same condition as w = MPN,
since W = P w and MRPN = P MPN
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3-19
Table 3.2: The Clip Joint’s Production
Function
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3-20
The 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
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3-21
The Demand for Labor
• How much labor do firms want to use?
– Analysis at the margin: costs and benefits of
hiring one extra worker (Fig. 3.5)
• If real wage (w) marginal product of labor (MPN),
profit rises if number of workers declines
• If w MPN, profit rises if number of workers increases
• Firms’ profits are highest when w = MPN
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3-22
Figure 3.5: The determination of labor
demand
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3-23
Summary 2: Comparing the Benefits and
Costs of Changing the Amount of Labor
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3-24
The Demand for Labor
• The marginal product of labor and the labor
demand curve
– Labor demand curve shows relationship between
the real wage rate and the quantity of labor
demanded
– It is the same as the MPN curve, since w = MPN
at equilibrium
– So the labor demand curve is downward sloping;
firms want to hire less labor, the higher the real
wage
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3-25
The Demand for Labor
• Factors that shift the labor demand curve
– Note: A change in the wage causes a movement
along the labor demand curve, not a shift of the
curve
– Supply shocks: Beneficial supply shock raises
MPN, so shifts labor demand curve to the right;
opposite for adverse supply shock
– Size of capital stock: Higher capital stock raises
MPN, so shifts labor demand curve to the right;
opposite for lower capital stock
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3-26
Table 3.3: The Clip Joint’s Production
Function after a Beneficial Productivity
Shock
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3-27
The Demand for Labor
• Aggregate labor demand
– Aggregate labor demand is the sum of all firms’
labor demand
– Same factors (supply shocks, size of capital
stock) that shift firms’ labor demand cause
shifts in aggregate labor demand
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3-28
Figure 3.6: The effect of a beneficial
supply shock on labor demand
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3-29
Summary 3: Factors That Shift the
Aggregate Labor Demand Curve
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3-30
The Supply of Labor
• Supply of labor is determined by individuals
– Aggregate supply of labor is the sum of
individuals’ labor supply
– Labor supply of individuals depends on laborleisure choice
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3-31
The Supply of Labor
• The income-leisure trade-off
– Utility depends on consumption and leisure
– Need to compare costs and benefits of working
another day
• Costs: Loss of leisure time
• Benefits: More consumption, since income is higher
– If benefits of working another day exceed costs,
work another day
– Keep working additional days until benefits
equal costs
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3-32
The Supply of Labor
• Real wages and labor supply
– An increase in the real wage has offsetting
income and substitution effects
• Substitution effect: Higher real wage encourages work,
since reward for working is higher
• Income effect: Higher real wage increases income for
same amount of work time, so person can afford more
leisure, so will supply less labor
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3-33
The Supply of Labor
• Real wages and labor supply
– A pure substitution effect: a one-day rise in the
real wage
– A temporary real wage increase has just a pure
substitution effect, since the effect on wealth is
negligible
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3-34
The Supply of Labor
• Real wages and labor supply
– 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 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
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3-35
The Supply of Labor
• Real wages and labor supply
– The substitution effect and the income effect
together: a long-term increase in the real wage
• The reward to working is greater: a substitution effect
toward more work
• But with higher wage, a person doesn’t need to work
as much: an income effect toward less work
• 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
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3-36
The Supply of Labor
• Real wages and labor supply
– Empirical evidence on real wages and labor
supply
• Overall result: Labor supply increases with a temporary
rise in the real wage
• Labor supply falls with a permanent increase in the real
wage
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3-37
The Supply of Labor
• Real wages and labor supply
– The labor supply curve (Fig. 3.7)
• Increase in the current real wage should raise quantity
of labor supplied
• Labor supply curve relates quantity of labor supplied to
real wage
• Labor supply curve slopes upward because higher wage
encourages people to work more
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3-38
Figure 3.7: The labor supply curve of an
individual worker
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3-39
The Supply of Labor
• Factors that shift the labor supply curve
– Wealth: Higher wealth reduces labor supply
(shifts labor supply curve to the left, as in
Fig. 3.8)
– Expected future real wage: Higher expected
future real wage is like an increase in wealth,
so reduces labor supply (shifts labor supply
curve to the left)
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3-40
Figure 3.8: The effect on labor supply
of an increase in wealth
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3-41
The Supply of Labor
• Aggregate labor supply
– Aggregate labor supply rises when current real
wage rises
• Some people work more hours
• Other people enter labor force
• Result: Aggregate labor supply curve slopes upward
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3-42
The Supply of Labor
• Aggregate labor supply
– Factors increasing labor supply
• Decrease in wealth
• Decrease in expected future real wage
• Increase in working-age population (higher birth rate,
immigration)
• Increase in labor force participation (increased female
labor participation, elimination of mandatory
retirement)
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3-43
Summary 4: Factors That Shift the
Aggregate Labor Supply Curve
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3-44
Labor Market Equilibrium
• Equilibrium: Labor supply equals labor
demand
• Key Diagram 2
• Fig. 3.9
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3-45
Figure 3.9: Labor market equilibrium
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3-46
Labor Market Equilibrium
• Classical model of the labor market—real
wage adjusts quickly
• Determines full-employment level of
employment and market-clearing real wage
• Problem with classical model: can’t study
unemployment
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3-47
Labor Market Equilibrium
• Full-employment output
• Full-employment output = potential output
= level of output when labor market is in
equilibrium
Y = AF ( K , N )
(3.4)
• Affected by changes in full employment level
or production function (example: supply shock,
Fig. 3.10)
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3-48
Figure 3.10: Effects of a temporary
adverse supply shock on the labor
market
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3-49
Labor Market Equilibrium
• Application: output, employment, and the
real wage during oil price shocks
– Sharp oil price increases in 1973–1974,
1979–1980, 2003–2008 (Fig. 3.11)
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3-50
Figure 3.11: Relative price of energy,
1960–2014
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3-51
Labor Market Equilibrium
• Application: output, employment, and the
real wage during oil price shocks
– Adverse supply shock—lowers labor demand,
employment, the real wage, and the fullemployment level of output
– First two cases: U.S. economy entered recessions
– Research result: 10% increase in price of oil
reduces GDP by 0.4 percentage points
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3-52
Unemployment
• Measuring unemployment
– Categories: employed, unemployed, not in the
labor force
– Labor Force = Employed + Unemployed
– Unemployment Rate = Unemployed/Labor Force
– Participation Rate = Labor Force/Adult Population
– Employment Ratio = Employed/Adult Population
– Table 3.4 shows current data
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3-53
Table 3.4: Employment Status of the U.S.
Adult Population, May 2015
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3-54
Unemployment
• Changes in employment status
– Flows between categories (Fig. 3.12)
– Discouraged workers: people who have become so
discouraged by lack of success at finding a job that
they stop searching
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3-55
Figure 3.12: Changes in employment
status in a typical month (May 2015)
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3-56
Unemployment
• How long are people unemployed?
– Most unemployment spells are of short duration
• Unemployment spell = period of time an individual is
continuously unemployed
• Duration = length of unemployment spell
– Most unemployed people on a given date are
experiencing unemployment spells of long duration
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3-57
Unemployment
• How long are people unemployed?
– Numerical example:
• Labor force = 100; on the first day of every month, two
workers become unemployed for one month each; on the
first day of every year, four workers become unemployed
for one year each
• Result: 28 spells of unemployment during a year; 24 short
(one month), four long (one year); so most spells are
short
• At any date, unemployment = six; four have long spells
(one year), two have short spells (one month); so most
unemployed people on a given date have long spells
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3-58
Unemployment
• Application: Unemployment Duration and
the 2007-2009 Recession
– Mean duration of unemployment rises in
recessions
– In 2007-2009 recession, the rise in duration
was larger than ever before (Fig. 3.13)
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3-59
Figure 3.13: Mean duration of
unemployment, 1960–2015
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3-60
Unemployment
• Application: Unemployment Duration and
the 2007-2009 Recession
– Four possible explanations for the increase in
duration
•
•
•
•
measurement issues
the extension of unemployment benefits
very large job losses
weak economic recovery
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3-61
Unemployment
• Why there are always unemployed people
– Frictional unemployment
• Search activity of firms and workers due to
heterogeneity
• Matching process takes time
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3-62
Unemployment
• Why there are always unemployed people
– Structural unemployment
• Chronically unemployed: workers who are unemployed
a large part of the time
• Structural unemployment: the long-term and chronic
unemployment that exists even when the economy is
not in a recession
• One cause: Lack of skills prevents some workers from
finding long-term employment
• Another cause: Reallocation of workers out of shrinking
industries or depressed regions; matching takes a long
time
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3-63
Unemployment
• The natural rate of unemployment (u)
– natural rate of unemployment; when output and
employment are at full-employment levels
= frictional + structural unemployment
– Cyclical unemployment: difference between actual
unemployment rate and natural rate of unemployment
u −u
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3-64
Unemployment
• In touch with data and research: labor
market data
– BLS employment report
• Household survey: unemployment, employment
• Establishment survey: jobs
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3-65
Unemployment
• In touch with data and research: alternative
measures of the unemployment rate
– U-1: unemployed 15 weeks or more
– U-2: counts job losers or persons who completed
temporary jobs, so it does not count people who
have quit their jobs
– U-3: the official rate, as defined in textbook
– U-4: like U-3 but adds discouraged workers
(those not looking for work because they do not
think they can find a job)
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3-66
Unemployment
• In touch with data and research: alternative
measures of the unemployment rate
– U-5: like U-4 but adds marginally attached
workers (those who say they are not looking for
work but indicate that they want and are
available for a job and have looked for work
sometime in the past 12 months)
– U-6: like U-5 but adds persons who are
employed part time for economic reasons (those
who want and are available for full-time work
but have had to settle for a part-time schedule)
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3-67
Unemployment
• In touch with data and research: alternative
measures of the unemployment rate
– Graph (text Fig. 3.14) shows that all measures
move similarly over time
– However, U-6 measure in 2015 is quite elevated
relative to its past level, while U-3 has returned
to a normal level by 2015
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3-68
Figure 3.14: Alternative Measures
of Unemployment, 1994–2015
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3-69
Relating Output and Unemployment:
Okun’s Law
• Relationship between output (relative to
full-employment output) and cyclical
unemployment
Y −Y
= 2(u − u )
Y
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(3.5)
3-70
Relating Output and Unemployment:
Okun’s Law
• Why is the Okun’s Law coefficient 2, and
not 1?
– Other things happen when cyclical
unemployment rises: Labor force falls, hours of
work per worker decline, average productivity of
labor declines
– Result is 2% reduction in output associated with
1 percentage point increase in unemployment
rate
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3-71
Relating Output and Unemployment:
Okun’s Law
• Alternative formulation if average growth
rate of full-employment output is 3%:
Y/Y = 3 – 2 u
(3.6)
• Fig. 3.15 shows U.S. data
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3-72
Figure 3.15: Okun’s law in the United
States: 1951–2014
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3-73
Key Diagram1: The production function
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3-74
Key Diagram2: The labor market
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3-75
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3-76
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