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Unformatted text preview: 121 8 THE ECONOMY AT FULL EMPLOYMENT: THE CLASSICAL MODEL* * This is Chapter 24 in Economics . K e y C o n c e p t s ¡ The Classical Model: A Preview Real variables, such as real GDP, employment, unem- ployment, saving, investment, and consumption tell us what is really happening to economic wellbeing. Nominal variables, such as the price level, the inflation rate, and nominal GDP, tell us how dollar values and the cost of living are changing. The classical dichotomy is the discovery that at full employment, the forces that determine real variables are independent of those that determine nominal vari- ables. The classical model is a model of an economy that determines the real variables at full employment. Most economists agree that the economy fluctuates around full employment, but classical economists think that the economy is always at full employment. ¡ Real GDP and Employment A production possibilities frontier between real GDP and leisure shows that GDP can be increased if time spent at leisure is decreased, that is, if employment is increased. The production function is the relationship between real GDP and the quantity of labor employed when all other influences on production remain the same. A production function is illustrated in Figure 8.1. ♦ When employment increases, there is a movement along the production function, as illustrated by the movement from point a to point b along PF . ¡ The Labor Market and Potential GDP The demand for labor and the supply of labor depend on the real wage rate , the quantity of goods and ser- vices an hour of labor earns. The money wage rate is the number of dollars an hour of labor earns. ♦ The real wage rate equals the money wage rate divided by the price level multiplied by 100. The demand for labor is the relationship between the real wage rate and the quantity of labor firms demand, where the quantity of labor demanded is the number of labor hours hired by all the firms in the economy. As the real wage rate increases, the quantity of labor de- manded decreases. ♦ The marginal product of labor is the additional real GDP produced by an additional hour of labor. C h a p t e r C H A P T E R 8 ( 2 4 ) 1 2 2 The law of diminishing returns states that as the quantity of labor increases, other things remaining the same, the marginal product of labor diminishes. ♦ Because the marginal product of labor diminishes as employment increases, firms hire additional workers only if the real wage rate falls. So the labor demand curve, LD illustrated in Figure 8.2, slopes downward. ♦ The demand for labor increases and the demand for labor curve shifts rightward when the marginal product of labor increases. The quantity of labor supplied is the number of labor hours that all the households plan to work. The supply of labor is the relationship between the quantity of labor supplied and the real wage rate when all other influences on work plans remain the same....
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This note was uploaded on 05/13/2010 for the course ECON 323 taught by Professor Jakes during the Spring '10 term at Alcorn State.
- Spring '10