Intermediate Macroeconomics

Lecture 7

David Goldbaum

Economics Discipline Group

University of Technology Sydney

Autumn 2020

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 1 / 28

Outline

1 Labour Markets
Demand for Labour
Supply of Labour
Supply of Labour
Labour Market Equilibrium

2 Supply Side constraints and the economy

Labour Markets
Full Employment Line

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 2 / 28

Outline

1 Labour Markets
Demand for Labour
Supply of Labour
Supply of Labour
Labour Market Equilibrium

2 Supply Side constraints and the economy

Labour Markets
Full Employment Line

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 3 / 28

Inputs

Firms make decision about the quantity of labour and capital to employ for
production.
Changing capital is costly and requires time.
Changing labour can be accomplished instantaneously (in the absence
of labour law constraints)
For short horizons, firms treat capital as given and optimize by
adjusting how much labour to employ

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 4 / 28

Labour Markets

The amount of labour employed in production is determined by the

households who supply labour and by the firms that employ the labour in
production. These two parties interact in the labour market.
Assumptions for simple model of labour markets
I Homogeneous Workers: Allows us to focus on the role of markets and
institutions. Does not alter the main conclusions. Will examine worker
differentiation later.
I Utility Maximizing Workers: Workers supply at a quantity to maximize
utility.
I Profit Maximizing Firms: Firms make hiring decisions to maximize
profits.
I Competitive Labour Markets: Workers and employers interact in
markets. Wages are set to clear the market. Each firm and each
household is a “price taker” in wages.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 5 / 28

Labour Demand
EiiEEIn
Profit maximization t.fi
Conceptually: A firm considers whether a worker contributes more to
the firm’s revenue than the worker costs to employ
Mathematically: With a MPN that is decreasing in N, a firm employs
workers to the point that the marginal benefit of the last worker
equals the marginal cost of the worker.
I The marginal benefit is the Marginal Revenue Product of Labour
(MRPN = p · MPN)
a W
I The marginal cost is the worker’s wage (W )
I Profit maximizing condition is MRPN = W

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 6 / 28

Labour Demand
A simple discrete example

# of Workers # of Dogs groomed MPN MRPN = P · MPN

(P=$10)
0 0 — —
1 11 11 110
2 20
3 O27
O97 90
O
70
4 32 5 50
5 35 3 30
6 36 1 10
o
Table 1: Production by number of workers

The number of workers hired depends on the wage

at W = $60, the 3rd employee generates a profit ($70-$60=$10) but
the 4th employee generates a loss ($50-$60=-$10).
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 7 / 28
Labour Demand
A simple discrete example

# of Workers # of Dogs groomed MPN MRPN = P · MPN

(P=$10)
0 0 — —
1 11 11 110
2 20 9 90
3 27 7 70 i

4 32 5 6 50 60
5 35 3 30
6 36 1 10
Table 1: Production by number of workers

The number of workers hired depends on the wage E

O
at W = $60, the 3rd employee generates a profit ($70-$60=$10) but
the 4th employee generates a loss ($50-$60=-$10).
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 7 / 28
Labour Demand

Convert from Nominal to Real

MRPN = W
MRPN/P = W /P
MPN = w
0
At a real wage of 6 units of output, the firm hires the 3rd worker, who
produces 7 units of output, but not the 4th, who produces only 5.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 8 / 28

Labour Demand

Convert from Nominal to Real

MRPN = W
MRPN/P = W /P
MPN = w
At a real wage of 6 units of output, the firm hires the 3rd worker, who
produces 7 units of output, but not the 4th, who produces only 5.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 8 / 28

Labour Demand
Graphical representation of the Marginal Product of Labour

0
no
1
0
Figure 1: Labour Demand curve

Aggregate Labour Demand is simply the sum of individual firm-level

demand. The result is a downward sloping demand curve in labour.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 9 / 28

Labour Demand

Wiz
y
Movement along vs a shift in the labour demand curve u r
where132P
Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I is
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
F A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Demand

Movement along vs a shift in the labour demand curve

Movement along the ND curve
I As the real wage increases (decreases), firms decrease (increase) the
number of workers they employ in order to maximize profits.
I A high wage forces firms to only employ highly productive workers.
This is accomplished by hiring only a small number.
I A change in P affects labour demand by changing the real wage
Shifts in the ND curve
I
O
A shift occurs when, for a given wage, firms change the number of
workers in order to maximize profits.
I This can be brought about from a change in worker productivity
F A change in A
Factor productivity
F

JE
A change in K

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 10 / 28

Labour Supply
u cc e
Using the standard tools of microeconomic analysis
4
Workers have two inputs to utility. Both are goods contributing
positively to utility
I Leisure: Time spent not working. Can be enjoyed in and of itself. a
I Consumption: Requires production in order to be enjoyed
Workers have two uses for their time
I Enjoying leisure
I Engaged in work in order to generate consumption items
Employing standard microeconomic analsyis,
I Workers choose between the two things that generate utility,
consumption and leisure
I But consumption only comes about through work, so can replace
consumption with work
I The “Budget Constraint” is the worker’s available time

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 11 / 28

Labour Supply

Using the standard tools of microeconomic analysis

4
Workers have two inputs to utility. Both are goods contributing
positively to utility
I Leisure: Time spent not working. Can be enjoyed in and of itself.
I Consumption: Requires production in order to be enjoyed
Workers have two uses for their time
I Enjoying leisure
I Engaged in work in order to generate consumption items
Employing standard microeconomic analsyis,
I Workers choose between the two things that generate utility,
consumption and leisure
I But consumption only comes about through work, so can replace
consumption with work
I The “Budget Constraint” is the worker’s available time

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 11 / 28

Labour Supply

Using the standard tools of microeconomic analysis

Workers have two inputs to utility. Both are goods contributing
positively to utility
I Leisure: Time spent not working. Can be enjoyed in and of itself.
I Consumption: Requires production in order to be enjoyed
Workers have two uses for their time
I Enjoying leisure
I Engaged in work in order to generate consumption items
Employing standard microeconomic analsyis,
I Workers choose between the two things that generate utility,
consumption and leisure
I But consumption only comes about through work, so can replace
consumption with work
I The “Budget Constraint” is the worker’s available time

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 11 / 28

Labour Supply

A concept from microeconomics

Given two goods to choose from, if the relative price between the two
goods changes, the one event has two effects
I Substitution effect: shift away from the more expensive good towards
more consumption of the cheaper good.
F A price decrease for good 1 will induce a shift in spending away from
good 2 towards good 1.
I Income effect: The price change alters the overall affordability of the
entire consumption package.
F A price decrease for good 1 frees up funds to be spent on more
consumption of both good 1 and good 2.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 12 / 28

Labour Supply
Each potential worker must decide how much labour to supply (if any) by
comparing the economic rewards (wages) with the lost opportunity to
engage in other non-employment activities (leisure, school, home/family
care).
wt co es
Substitution effect: the higher the real wage, the greater the
opportunity cost to engaging in leisure. Substitute away from the
expensive leisure towards relatively cheap consumption
I High w means consume more and work more (less leisure)

o
Income effect: The higher the wage, the greater the income. Leisure is
a “good” that the higher income can be used to purchase. A higher
wage means more income for both consumption and leisure
I High w means consume more and work less (in order to take more
leisure time) r ble
9 et cud
For now, assume the substitution effect dominates. Will return to this issue
when considering the business cycle.

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 13 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
I Individual decisions to work can be affected by
F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
F Changes in the working age population: Population dynamics such as
the “Baby Boomers” or changes in what is considered “working
rn age”.
F Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
I Individual decisions to work can be affected by
F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
F Changes in the working age population: Population dynamics such as
the “Baby Boomers” or changes in what is considered “working age”.
F Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours

3
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
I Individual decisions to work can be affected by
F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
F Changes in the working age population: Population dynamics such as
the “Baby Boomers” or changes in what is considered “working age”.
F Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
Individual decisions to work can be affected by

it i
I

F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
F Changes in the working age population: Population dynamics such as
the “Baby Boomers” or changes in what is considered “working age”.
F Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
I Individual decisions to work can be affected by
F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
F Changes in the working age population: Population dynamics such as
the “Baby Boomers” or changes in what is considered “working age”.
F Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Supply
Household decide how to allocate time between work and leisure
Movement along a NS curve
I A high (low) real wage will induce workers to put in more (fewer) hours
of work, substituting away from leisure.
I a high real wage will draw more people into the labour force. A low
real wage will cause some workers to leave the labour force in favour of
non-employment activities.
Shifts in the NS curve are caused by factors that change the desire to
work at a given real wage
I Individual decisions to work can be affected by
F Wealth
F Expected future real wages
I Aggregate factors that change the size of the labour force
Changes in the working age population: Population dynamics such as

I
F

c F
the “Baby Boomers” or changes in what is considered “working age”.
Participation rates: Changes in the attitude towards working women

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 14 / 28

Labour Market Equilibrium
Observe
The equilibrium wage sets ND=NS

Yi AE In equilibrium, W/P=MPN=slope of
A kiefthe production function
men

r s

O a mi
ND

Figure 2: Labour Market in Equilibrium

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 15 / 28

Labour Market Equilibrium
Observe
The equilibrium wage sets ND=NS

9 In equilibrium, W/P=MPN=slope of
the production function
ties After a Technology Shock (A2>A1)
I
Productivity at N ⇤ is increased
ND shifts right so that at N ⇤ , the
wage reflects the new MPN.
In equilibrium, N increases to N2⇤
us I At the higher N, the MPN

decreases some, but remains

above the original MPN.
n
N D2
ND e

Figure 3: Labour Market in Equilibrium

(technology shock)
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 16 / 28
Unemployment:Types of Unemployment I

1
t
Frictional Unemployment: Worker’s skills are valued and employers
have positions to hire into
I Job separation is voluntary or the worker is a new entrant to the job
market
I Tends to lead to a better allocation of resources by separating workers
and employers when there is a bad fit. Includes job termination due to
F A worker seeks a new job in the same location
A worker seeks a new job in a new sector of the economy
I
F
F A worker seeks a new job in a new location
F A worker is fired due to a poor match of skills with those required for

I
C the position
Typically short-term in duration

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 17 / 28

Unemployment:Types of Unemployment II
2 Structural Unemployment: Worker’s skills are not valued
I The result of a structural change in the economy such as changes in
technology, international trade, or in consumer preferences that make
job skills obsolete

I
I Remain unemployed until the worker is retrained in new skills in
demand in the altered economy
I Unpleasant but necessary in a dynamic evolving economy.
F Politicians often lament the loss of jobs in a declining sector (ex.: coal
energy) but to provide public support to preserve jobs in declining
industries is inefficient and can results in a larger adjustment at a
future date when the public support becomes unsustainable.
F Typesetter, telephone operator, textile worker in a developed economy

a
F Counter example: “Dutch Disease” as it applies to mining in Australia
I Typically long-term in duration.
3 Seasonal Unemployment: Worker’s skills have seasonal value
I Prevalent in seasonal industries (tourism, construction, retail, ...)
I Unemployment can be expected to end next season

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 18 / 28

Unemployment:Types of Unemployment III

4 Cyclical Unemployment: Worker’s skills still valued but employers do

not have a position to hire worker into due to a Business Cycle decline
I The worker has a desired skill (not obsolete) and a desire to work, but
due to recessionary condition, cannot find an opening
I The cyclically unemployed worker would expect to return to the same
or similar job at the next upturn in the economy
I Unemployment lasts until economic and labour market recovery
L

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 19 / 28

Outline

1 Labour Markets
Demand for Labour
Supply of Labour
Supply of Labour
Labour Market Equilibrium

2 Supply Side constraints and the economy

Labour Markets
Full Employment Line

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 20 / 28

Natural Rate of Unemployment

Natural Rate of Unemployment (u ⇤ )

I
O
The unemployment rate that is the result of counting those unemployed
as a result of Frictional, Structural, and Seasonal unemployment
The Natural level of Output:
I The output Y ⇤ that occurs at the natural rate of unemployment
u = u ⇤ , so that the number of employed workers is N = N ⇤ .

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 21 / 28

Natural Rate of Unemployment

Cyclical
Natural Rate of Unemployment (u ⇤ )
I
L
The unemployment rate that is the result of counting those unemployed
as a result of Frictional, Structural, and Seasonal unemployment

T
The Natural level of Output:
I The output Y ⇤ that occurs at the natural rate of unemployment
u = u ⇤ , so that the number of employed workers is N = N ⇤ .

IE
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 21 / 28
Labour Markets

Natural level of employment: u = u ⇤ , N = N ⇤

Natural level of output: Y ⇤ = AF (K , N ⇤ )
Output deviation Y 6= Y ⇤ can emerge in a demand driven economy
The difference between actual and potential output is usually
attributed to disequilibrium in the labour market,

o
I Y 6= Y ⇤ , N 6= N ⇤ , u 6= u ⇤

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 22 / 28

Labour Markets
Consider a shock to the labour market
W!P A functioning efficient labour
NS
market,
Wages adjust quickly to
a new market condition
W2 !P The new market clearing
W!P an
wage is W2 /P
At W2 /P, NS = ND
ND
with N = N2⇤
N

Ou
N! N2!

Figure 4: New Labour Market Equilibrum

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 23 / 28

Labour Markets
Consider a shock to the labour market
W!P Kumamoyed
An inefficient labour market,

EYE NS Wages adjust slowly to

new market conditions
Produces disequilibrium
I W /P too high:
W!P ao g NS > ND ) high
unemployment
(u > u ⇤ )

T
ND
I W /P too low:

0
N NS < ND ) scarcity
O
NS!N " ND
of workers (u < u ⇤ )
N o
Figure 5: Labour Market Disequilibrum F

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 24 / 28

Full Employment Line
Add the FE line to the IS-LM space
r FE represents all points at
which the labour market is in
O
FE LM
equilibrium
The labour market is in
equilibrium if
r N = N ⇤ , u = u⇤

Ly
For N = N ⇤ ) Y =
Y ⇤ = AF (K , N ⇤ ),
IS
natural level of
Y employment produces
Y Q
Y!
etECE Ne
the natural level of
output
Figure 6: IS-LM-FE
The FE line is vertical
at Y ⇤

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 25 / 28

Full Employment Line

Shifts in the FE curve

The position of the FE curve is defined by the production function:
I
Y ⇤ = AF (K , N ⇤ )
The FE curve shifts as a result of a change in labour productivity
I A change in A or in K changes what can be produced from the same
sized labour force
F " A and " K will produce " Y ⇤ for the same N ⇤
I ) Demand shocks do not shift the FE curve q
1
i
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 26 / 28
IS-LM-FE Analysis

iii
Output is determined by IS = LM
If IS = LM to the left of FE , then Y < Y ⇤ , the economy is
under-producing
I The economy is under-utilizing its resources, namely labour
If IS = LM to the right of FE , then Y > Y ⇤ , the economy is
over-producing
I The economy is over-utilizing its resources, namely labour

i i
David Goldbaum (UTS) Lecture 7 Interm Macro 2020 27 / 28
IS-LM-FE Analysis

Economic self-correction
Under-utilization of resources it
I over time, the price of inputs (namely labour) declines
I In a competitive setting, firms will lower prices so that the price level
declines

00
) P #) Ms P ") r #) LM shifts right (down) ) Y " 0
I
I Process continues until IS = LM = FE ) Y = Y ⇤
Over-utilization of resources
I over time, the price of inputs (namely labour) increase
I In a competitive setting, firms will raise prices so that the price level
increases
I

I 000
) P ") Ms P #) r ") LM shifts left (up) ) Y #
Process continues until IS = LM = FE ) Y = Y ⇤
Note: a change to P has no impact on Md/P because nominal money
demand changes with the price level

David Goldbaum (UTS) Lecture 7 Interm Macro 2020 28 / 28