Section 7 - AS-AD and Unemployment At the beginning of the...

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AS-AD and Unemployment
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At the beginning of the course we said that there were three main variables in which we would be interested → Output/Income → Inflation (Prices) → Unemployment Our goal is to see how government and Fed policies might affect these three variables Y P L
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We want to be able to easily see how P and Y are related Think back to our fully developed model → We have both P and Y represented Hence, we need to consider how they are related in the full model P Y
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Notice how Prices and Output are related Y C I r Y G C=a+b(Y-T) Output Market Money Market Y AE r Money M D (P*,Y*) M S r* r* I* G* C* Y* D =Y*-T* AE* = C* + I* + G* + (X-M)* AE* Y* I(r) Prices (X-M)* Y (X-M)
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Y C I r Y G C=a+b(Y-T) Output Market Money Market Y AE r Money M D (P*,Y*) M S r* r* I* G* C* Y D * 45° AE*=C*+I*+G* AE* Y* I(r) AE' Y' AE'=C*+I'+G* I' r' ↑r ↓AE ↓Y ↓I D r'' AE''=C*+I''+G* Y'' AE'' r'' ↓r I'' ↑I ↑AE ↑Y r' ↑P ↓P Higher P, Lower Y Lower P, Higher Y D ↓M
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So we have Higher P, Lower Y Lower P, Higher Y P Y P* P' Y* Y' This shows the relationship between the equilibrium Price level (P) and the equilibrium level of Output (Y) We call this relationship Aggregate Demand (AD) AD
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Now we need to think about production Everything goes back to the production function Y = f(K,L) As we said in the micro portion of the course, we tend to think of Capital (K) as fixed so the only variable input is Labor (L) So the main thing we need to worry about is how Output changes with Labor
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There are actually two ways that the variable input (L) can affect output (Y) (1) More units of labor (2) More “effective” units of labor So the amount of output produced depends on the amount of variable inputs (L) employed Y L Y' Y* L' L* Y'' L' Y' L' Y'' L) , K f( Y = L) , K ( f Y =
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Q: What are effective units of labor? A: How much each unit of labor produces. This is what we refer to as “human capital” → Amount of output one can produce per unit of labor → Depends on education and training → The greater the education or training the more output per unit of labor Human Capital
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Think about accounting Workers trained in a company’s accounting practices will be much more productive than those that are not Suppose firm decides to train all of its workers Example : Y L Y* L* Y'' L) , K f( Y = L) , K ( f Y = Trained workers Untrained workers Output will increase even though numbers of workers will not change
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This is why firms spend millions of dollars each year on worker training programs It is also why you spend good money to get a college education → Labor economic theory holds that firms pay workers in relation to their productivity level → Hence if you become more productive (get educated) you will be worth more to the firm and the firm will pay you more
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We need to think about employment The process through which employment is decided occurs in the Labor Market In the Labor Market we have two transactors (1) Households who might want to work (2) Firms who might want to hire workers Labor Supply Labor Demand
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Q: Who demands labor?
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This note was uploaded on 07/29/2009 for the course ECON 101 taught by Professor Bansak during the Spring '07 term at San Diego State.

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Section 7 - AS-AD and Unemployment At the beginning of the...

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