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longrun - E202 Long-run LONG-RUN ADJUSTMENT QUESTIONS What...

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E202 – Long-run 1 L ONG -R UN A DJUSTMENT F ACTS • Output grows • Deflation (falling prices) in 19th century Inflation (rising prices) in 20th century S ETTING Factor prices are flexible and adjust to equate supply and demand for factors of production • Goods prices are flexible Q UESTIONS What determines the trend level of output? Available factor supplies and technology • What explains growth in output? Expansion of factor supplies and improvement in technology • What determines long-run movements in prices? The monetary situation
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E202 – Long-run 2 O UTPUT L EVEL The level of output is related to the amounts of inputs used and the technology for using them. This can be represented by a production function. In general form: Q = f L , K , A ( ) A more specific form is: Q = L f K/L , A ( ) where: Q = real output L = labor used K/L = capital stock per labor unit A = level of technology and worker quality I NPUT U TILIZATION (L ONG -R UN ) In free markets prices adjust to produce full utilization of available resources. In the labor market the wage rate will adjusts to yield equilibrium with L = L . L W LD LRLS L
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E202 – Long-run 3 L ABOR M ARKET A DJUSTMENT Over time, wages adjust to give full-employment in the labor market. The unemployment rate will be at a level called the natural rate of unemployment ( ur ). L = L ur = ur In the short-run unemployment and labor use will fluctuate. In a recession recession period: Demand for labor is low, and unemployment is high. L < L ur > ur The wage rate will tend to fall. In a boom boom period: Demand for labor is high, and unemployment is low. L > L ur < ur The wage rate will tend to rise. O UTPUT L EVEL ( REVIEW ) The level of output is related to the amounts of inputs used and the technology for using them. This can be represented by a production function: Q = L f K/L , A ( ) where: Q = real output L = labor used K/L = capital stock per labor unit A = level of technology and worker quality In the long-run factor prices adjust to produce full utilization of available resources.
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