neoclassical macroeconomics

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28 Οκτ 2013 (πριν από 3 χρόνια και 9 μήνες)

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neoclassical macroeconomics

Full employment and the self
-
adjusting macroeconomy

neoclassical macro


Assume to begin with, a pure market
economy with no government and no
foreign trade.


We will also assume that labor demand is
wage
-
elastic, but we can worry about that
later.


assume markets are perfectly competitive

unemployment


Assume there is some unemployment due
to an exogenous shock to the economy


In neoclassical economics, if there is
unemployment:




labor supply (Ls) > labor demand (Ld)

More workers are ready and willing to
provide their labor services at the going
wage rate than firms are ready and willing
to hire.

the neoclassical labor market


In neoclassical economics, when there is
unemployment, we start with the labor
market, which works similarly to the
product markets in neoclassical theory,
except that there is a special kind of good,
called labor (L) or labor services, and a
special kind of price, called the wage.

Labor Market

w (real wage)

L (Labor)

Labor Supply (L
s
)

Labor Demand (L
d
)

w*

L*
(Ls = Ld)


0

neoclassical labor market


When there is unemployment, labor supply
is greater than labor demand, so the wage
must be above the equilibrium level.


Just as in neoclassical price theory,
competition between and among the
buyers and sellers will tend to push and
pull the market toward the equilibrium.

Labor Market When Going Wage is
Above Equilibrium Wage

w (real wage)

L (Labor)

Labor Supply (L
S
)

Labor Demand (L
D
)

w*

L
D
1

L
S
1

w
1

0

Labor Market When Going Wage is
Above Equilibrium Wage

w (real wage)

L (Labor)

Labor Supply (L
S
)

Labor Demand (L
D
)

w*

L
D
1

L
S
1

Excess Supply of Labor = L
S
1



L
D
1

w
1

0

equilibrating labor market


There are unemployment people who want
to work. Some offer to work for a little less
than the wage, w
1
, and when they do,
firms increase their demand to hire by a
little, and the supply contracts by a little. If
there is still an excess supply of labor
(unemployment) other unemployed
workers will offer to work for a little less,
and firms will increase their demand again.

neoclassical self
-
adjusting labor
market


This process continues until the wage
reaches w*, and labor supply and labor
demand are equal. Firms are able to buy
exactly the amount of labor services they
want at that wage rate, and everyone who
is willing and able to work at that wage
rate is working (full employment)


The labor market returns to equilibrium

Labor Market

w (real wage)

L (Labor)

Labor Supply (L
s
)

Labor Demand (L
d
)

w*

L* (L
s

= L
d
)

0

full employment


More people are working, so more
production is occurring, and more people
are working so more people are earning
income.


Output and income increase by the same
amount (national income accounting
identity):


Y (national output) = Y (national income)

Spending and sales


Who is going to purchase the additional
output produced by the newly employed
workers, hired as a result of the fall in the
wage?

Spending and sales


Who is going to purchase the additional
output produced by the newly employed
workers, hired as a result of the fall in the
wage?


Some will be purchased by the newly
employed workers, who will spend their
new income on goods and services.

Spending and sales


Who is going to purchase the additional
output produced by the newly employed
workers, hired as a result of the fall in the
wage?


Some will be purchased by the newly
employed workers, who will spend their
new income on goods and services.


Will they buy all of it?

Income, spending, and sales


Only if the newly employed all of their
income will they purchase the new output
in its entire.


Some people, especially with lower
incomes, spend all their income to live, but
as a society, we normally (but not always)
have some positive amount of savings (=
income not spend).

Savings, (not) spending, and sales


Savings is
income not spent.


Savings, (not) spending, and sales


Savings is
income not spent.


Savings is
output not sold
.

Savings, (not) spending, and sales


Savings is
income not spent.


Savings is
output not sold
.


Whatever the amount of savings is will
correspond exactly to the same amount of
output not sold. Firms will have excess
inventories, and they will cut back output.
When they cut back output, they lay off
workers, and income and spending fall
again.

full employment and

business sales


Businesses must have their level of output
validated or justified by sales. They
cannot continue to produce at a higher
level of production unless they can sell
that output. Otherwise, they will cut back
output, and when they do, they no longer
need as many workers.

savings and spending


Even in an economy with no government
and no foreign trade, there is another kind
of spending besides consumption
spending.

savings and spending


Even in an economy with no government
and no foreign trade, there is another kind
of spending besides consumption
spending.


Investment

savings and spending


Even in an economy with no government
and no foreign trade, there is another kind
of spending besides consumption
spending.


Investment


Must look to the neoclassical analysis of
savings and investment, or the
loanable
funds market.

Loanable Funds Market: savings
function (supply of loanable funds)

Interest Rate

S, I

S (Savings)

i
1


S
1

0

investment function:

demand for loanable funds

Interest Rate

S, I

I (Investment)

i
1

I
1

0

Loanable Funds Market


Interest Rate

S, I

S (Savings)

I (Investment)

i*

S = I

0

Analyzing the loanable funds
market


An increase in savings resulting from an
increase in income (rather than from a fall
in the interest rate) means that the savings
function (or supply of loanable funds
curve) shifts out.


Now, at the same old equilibrium rate of
interest that used to equate savings and
investment, savings is now higher.

Loanable Funds Market

Shift in Savings


Interest Rate

S, I

S
1

I

i
1


I
1


S
2

0

S
2


Banks with excess currency to lend start
lowering their interest rates to try to
undersell their competition.


As interest rates fall, investment demand
increases, and savings contracts by a little
bit.


If there are still excess loanable funds,
banks will cut interest rates again, and so
on.

Loanable Funds Market

Shift in Savings


Interest Rate

S, I

S
1

I

i
1

S
1

= I

S
2

S
2

= I

i
2

0

Neoclassical self
-
adjusting
mechanism: necessary and
sufficient conditions



When S rises, interest rates fall,
Investment increases, until:





S = I @ Yf


Perfectly flexible wages, prices, and interest
rates constitute the self
-
adjusting
mechanism that ensures a tendency to full
utilization of resources, including labor.

Necessary and sufficient conditions


Perfectly flexible wage is a necessary but
NOT sufficient condition for full
employment. Must also have perfectly
flexible interest rates.


Another way of stating it: all markets,
including factor markets, must be perfectly
competitive.

Minimum Wage Above Equilibrium
Wage

Wage

Quantity of Labor

L
S

L
D

w*

L
D
Min

L
S
Min

Unemployment = L
S
Min



L
D
Min

Min. Wage

0

Minimum Wage Below Equilibrium
Wage

Wage

Quantity of Labor

L
S

L
D

w*

L
S
Min

L
D
Min

Excess Demand

= L
D
Min



L
S
Min

Min. Wage

0