Chapter 3

 Production function: Y = AF(K, N),

Y = real output produced in a given period of time;
A = a number measuring overall productivity;
K = the capital stock, or quantity of capital used in the period;
N = the number of workers employed in the period;
F = a function relating output Y to capital K and labor N.
 two properties with most production functions:
1. The production function slopes upward from left to right. The slope of the production
function reveals that, as the capital stock increases, more output can be produced.
2. The slope of the production function becomes flatter from left to right. This property implies
that although more capital always leads to more output, it does so at a decreasing rate.
 marginal product of capital, or MPK, is the increase in output produced that results from a one-
unit increase in the capital stock.
 We can use the concept of the marginal product of capital to restate the two properties of
production functions listed earlier.
1, The marginal product of capital is positive. Whenever the capital stock is increased, more
output can be produced. Because the marginal product of capital is positive, the production
function slopes upward from left to right.
2. The marginal product of capital declines as the capital stock is increased. Because the
marginal product of capital is the slope of the production function, the slope of the production
function decreases as the capital stock is increased.
 The tendency for the marginal product of capital to decline as the amount of capital in use
increases is called the diminishing marginal productivity of capital.
 The marginal product of labor, or MPN, is the additional output produced by each additional
unit of labor, ΔY / ΔN.
 As with the marginal product of capital, for small increases in employment, the MPN can be
measured by the slope of the line tangent to a production function that relates output and
labor.
 The negative supply shock shifts the production function downward so that less output can be
produced for specific quantities of labor and capital. In addition, the supply shock shown
reduces the slope of the production function so that the output gains from adding a worker (the
marginal product of labor) are lower at every level of employment
 Conversely, a beneficial supply shock makes possible the production of more output with given
quantities of capital and labor and thus shifts the production function upward
 the marginal revenue product of labor, or MRPN, measures the benefit of employing an
additional worker in terms of the extra revenue produced
 MRPN = P x MPN
 Factors That Shift the Labor Demand Curve are supply shock and the size of the capital stock.
 Full employment output: Ybar = AF(K, Nbar)
 Structural unemployment refers to a mismatch between the jobs available and the skill
levels of the unemployed. It occurs when an underlying shift in the economy makes it
difficult for some groups to find jobs.
 Frictional unemployment: the unemployment which exists in any economy due to people
being in the process of moving from one job to another.
 The rate of unemployment that prevails when output and employment are at the full-
employment level is called the natural rate of unemployment, u bar
 The difference between the actual unemployment rate and the natural rate of unemployment is
called cyclical unemployment