¾ Supply shocks affect the amount of output that
can be produced for a given amount of inputs.
¾ Supply shocks shift the production function.
• Negative or adverse shock: A decline in A usually
causes the slope of production function to decrease at
each level of input.
• Also called productivity shocks.
• Positive or beneficial shock: An increase in A usually
causes the slope of production function to increase at
each level of input.
3-25
Effects of an Adverse Supply Shock
3-26
The Demand for Labor
Y
• The demand for labor is determined by
individual business firms.
Y = A0F(K0, N)
¾ The aggregate demand for labor is the sum of
all the business firms’ demand for labor.
• The demand for labor depends on the costs
and benefits of hiring additional workers.
N
3-27
3-28
7
The Demand for Labor
The Demand for Labor
• How much labor do firms want to use?
• What is the cost of hiring one more worker?
¾ Assumptions:
¾ The marginal cost of hiring one more worker is
the cost of that worker to the firm, i.e., the
nominal wage:
• The capital stock fixed, i.e., a short-run analysis.
• Workers are homogeneous.
W
• The labor market is competitive.
• Firms maximize profits.
3-29
3-30
The Demand for Labor
The Demand for Labor
• What is the benefit of hiring one more worker?
• How much labor do firms want to use?
¾ The benefit of hiring one more worker is the
additional income that the worker generates, i.e.,
the marginal revenue product of labor:
¾ A profit-maximizing firm will hire additional
workers up to the point where the marginal
revenue product of labor equals the nominal wage:
MRPN = P * MPN
W = MRPN = P * MPN
3-31
3-32
8
The Demand for Labor
Marginal Cost of Hiring an Extra Worker
w
• How much labor do firms want to use?
¾ This equilibrium condition:
W = MRPN = P * MPN
¾ can be re-written as:
w = MPN
• because w = W/P and MRPN = P * MPN.
N
3-33
Marginal Benefit of Hiring an Extra Worker
MPN
3-34
The Determination of Labor Demand
w, MPN
N
N
3-35
3-36
9
The Demand for Labor
The Demand for Labor
• How much labor do firms want to use?
• How much labor do firms want to use?
¾ Costs and benefits of hiring one extra worker.
¾ The labor demand curve shows the relationship
between the real wage rate (w) and the quantity of
labor demanded (N).
• If w > MPN, profits rise if number of workers declines.
• If w < MPN, profits rise if number of workers increases.
• When w = MPN, profits are maximized.
3-37
Determination of the Labor Demand Curve
3-38
The Demand for Labor
w, MPN
• The Labor Demand Curve, ND.
¾ Changing the real wage rate:
• An increase in the real wage rate means w > MPN
unless N is reduced so the MPN increases.
w0
w0
• A decrease in the real wage rate means w < MPN
unless N is increased so the MPN decreases.
MPN
N0
N
3-39
3-40
10
The Demand for Labor
The (Aggregate) Labor Demand Curve
w, MPN
• The Labor Demand Curve, ND.
¾ The labor demand curve is downward sloping.
• The higher the real wage, the less labor firms will hire.
¾ Because w = MPN in equilibrium (regardless of
what w is), the ND curve is the same as the MPN
curve.
N
3-41
The Demand for Labor
3-42
Effect of an Increase in K or A
w, MPN
• Factors that shift the labor demand curve:
¾ Changes in the capital stock, ΔK.
• Increases in K raise MPN and shift the labor demand
curve to the right.
¾ Supply shocks, ΔA.
• Beneficial supply shocks raise MPN and shift the labor
demand curve to the right.
ND0
N
3-43
3-44
11
Key Diagram #1: The Production Function
Key Diagram #2a: Demand for Labor
Y
w, MPN
Y = A0F(K0, N)
ND0
N
N
3-45
3-46
Key Diagrams #1 & #2a.
• Factors that Shift the Production Function and
the Demand for Labor:
¾ Increases in the capital stock, K, shift the
production function higher, increase the MPN and
the demand for labor.
¾ Increases in productivity, A, shift the production
function higher, increase the MPN and the
demand for labor.
3-47