Macroeconomics: Production and Supply

• These notes discuss production and supply in macroeconomics.

Supply and Demand in Macro

• Supply and demand are established concepts in microeconomics.
• These concepts are also used in macroeconomics, but the interpretations can differ slightly.
• Aggregate supply and aggregate demand can be obtained by summing over all actors in micro.
• Chapter 3 focuses on the supply side, while chapter 4 focuses on the demand side.

The Supply Side

• Introduces standard microeconomic concepts.
• Incorporates assumptions that make the analysis Keynesian.
• Focuses on how firms set prices.
• Firms use a markup on marginal cost to set prices.
• Short-term rigidities are also a factor.

Production Function

• Production processes are summarized by a production function.
• Input factors are put into a production process to generate a "macro good."
• Y = F (K,N), where Y is output, K is capital, and N is labor.
• Y = A F (K,N), where A is the level of technology is constant in the short-term.
• K and N could be disaggregated into different types of capital and labor.

Mathematical Forms

• Various functional forms can be assumed.
• Examples include Cobb-Douglas and linear functions.

Returns to Scale

• Returns to scale can be decreasing (diseconomies of scale).
• Returns to scale can be constant.
• Returns to scale can be increasing (economies of scale).
• The most likely return to scale at the margin should be considered.

Marginal Product/Marginal Cost

• Marginal product is the derivative of the production function with respect to one of the input factors.
• Marginal cost is the incremental cost of producing one additional unit.
• MK = W/ MPN, where W is wages and MPN is the marginal product of labor.
• Holding K constant while varying N, MPN is the extra production obtained; 1/MPN is the labor needed for one extra unit.
• W is the price of labor.

Assumption: Price Markup

• Assumes monopolistic competition.
• Pricing is determined by P = (1 + μ) ΜΚ where μ is the markup and MK is the marginal cost.
• μ can be interpreted as "elasticity" in demand.

The Supply Side in Keynesian Macro

• Firms set prices as a markup on marginal cost.
• Firms produce and sell what is demanded.
• Production changes occur without significant changes in product prices (rigid prices).
• Keynes' central assumption is that demand changes affect produced volume, not prices.
• This short-term assumption implies managing demand is politically important.

Production and Employment

• u = U/L, where L is the labor force and N is the employed.
• N = L - U = L - uL = (1 – u)L
• Y = F (K, (1-u)L)

Measuring Unemployment

• AKU: labor force survey.
• Registered unemployment (with or without people on employment schemes).
• AKU unemployment is usually higher than registered unemployment.
• Unemployment is measured as a percentage of the labor force.
• The labor force in Norway is about 3 million.
• Many people are outside the labor force, for example, on disability benefits.
• This complicating cross-country comparisons of unemployment.
• In late 2024, 74,100 people were registered as fully unemployed or seeking employment through labor market measures at NAV which makes up 2.5% of the workforce.

Growth and Full Employment

• Okun's Law: a higher growth rate in GDP lowers unemployment
  • "One percentage point of higher growth in GDP gives a 0.25 percentage point reduction in unemployment."
• Productivity growth weakens employment, requiring new jobs to employ everyone.
• In the long-term equilibrium, wages adjust to ensure everyone is employed, regardless of the growth rate.

Types of Unemployment

• Frictional unemployment
• Structural unemployment
• Cyclical unemployment
• «Equilibrium unemployment» (NAIRU) – no cyclical unemployment
• Y-n = F (K, 1 – (u-n) L) - "Potential GDP" when u-n is zero.