Part 2 Week 1 (Sessions 1-4).pptx

Principles to Macroeconomics ECON102 Part 2 The Economy in the Long-Run Priyanka Harrichurran:  Principles of Macroec...

Principles to Macroeconomics ECON102 Part 2 The Economy in the Long-Run Priyanka Harrichurran:  Principles of Macroeconomics ECON102 Session 1 - 2: The Classical Model: Real GDP, Employment, the Labour Market and Potential GDP Reading: Parkin, 3rd ed., Ch 21 p. 472; Ch 24 pp. 538 - 545 Parkin, 2nd ed., Ch 23 pp. 504 - 510 Key concepts Production possibilities frontier The production function Demand for labour Supply of labour Market equilibrium Growth of labour productivity Priyanka Harrichurran [email protected] 2  Principles of Macroeconomics ECON102 How Potential GDP Grows Economic growth occurs when real GDP increases. Economic growth → a sustained year after year increase in potential GDP What Determines Potential GDP? Factors of production produce real GDP o The productivity of the factors of productions determine the quantity of real GDP that can be produced o Potential GDP is the level of real GDP when all the factors of production are fully employed To determine potential GDP, we use a model with two components: o an aggregate production function o an aggregate labour market. Priyanka Harrichurran [email protected] 3  Principles of Macroeconomics ECON102 What Determines Potential GDP? Aggregate Production Function Aggregate Production Function: the relationship that tells us how real GDP changes as the quantity of labour changes, c.p. Quantity of leisure is the number of hours spent not working o If we only spend time on leisure then we produce nothing and Real GDP=0. o The more leisure time we give up, the greater is the quantity of labour supplied and the greater is the quantity of real GDP produced. But labour hours are not all equally productive – diminishing returns (therefore, slope of Aggregate Production Function gets flatter and flatter) Priyanka Harrichurran [email protected] 4  Principles of Macroeconomics ECON102 Aggregate Labour Market In macroeconomics, we assume that there is one large labour market that determines the quantity of labour employed and the quantity of real GDP produced Demand for Labour: relationship between the quantity of labour demanded and the real wage rate Quantity of labour demanded – no. of labour hours hired by all firms in the economy in a given period o Depends on the price of labour (real wage rate)  The quantity of labour demanded increases as the real wage rate decreases (due to the downward slope of the demand curve) 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑜𝑟 𝑚𝑜𝑛𝑒𝑦 𝑤𝑎𝑔𝑒 𝑟𝑎𝑡𝑒 𝑅𝑒𝑎𝑙𝑤𝑎𝑔𝑒 𝑟𝑎𝑡𝑒= 𝑃 𝑟𝑖𝑐𝑒𝑙𝑒𝑣𝑒𝑙 Priyanka Harrichurran [email protected] 5  Principles of Macroeconomics ECON102 Aggregate Labour Market In macroeconomics, we assume that there is one large labour market that determines the quantity of labour employed and the quantity of real GDP produced Supply of Labour: relationship between the quantity of labour supplied and the real wage rate Quantity of labour supplied – no. of labour hours that all households in the economy plan to work in a given period o Depends on the price of labour (real wage rate)  The quantity of labour supplied increases as the real wage rate increases (due to the upward slope of the labour supply curve) Priyanka Harrichurran [email protected] 6  Principles of Macroeconomics ECON102 Aggregate Labour Market If there is a shortage of labour (quantity of labour demanded is greater than quantity of labour supplied): o The real wage rises to eliminate the shortage If there is a surplus of labour (quantity of labour supplied is greater than quantity of labour demanded): o The real wage falls to eliminate the surplus Equilibrium occurs when there is no shortage or surplus At equilibrium: o the economy is at full-employment o Real GDP = potential GDP o Unemployment is at the natural rate Priyanka Harrichurran [email protected] 7  Principles of Macroeconomics ECON102 What Makes Potential GDP Grow? Growth of the Supply of Labour When labour supply grows, the supply of labour curve shifts rightward The quantity of labour changes as a result of changes in: o average hours per worker o the employment-to-population ratio o the working-age population Example: Population growth o Higher quantity of labour supplied but same quantity of labour demanded  Surplus  Unemployment will be above the natural rate of unemployment  Real wage rate falls to eliminate surplus Priyanka Harrichurran [email protected] 8  Principles of Macroeconomics ECON102 What Makes Potential GDP Grow? Growth of Labour Productivity Labour Productivity: the quantity of real GDP produced by an hour of labour If labour productivity increases, production possibilities expand. Quantity of real GDP that any given quantity of labour can produce increases Labour is more productive - firms willing to pay more and demand increases Potential GDP increases because o Labour is more productive o More labour is employed Example: Effects of an increase in labour productivity o Higher quantity of labour demanded but same quantity of labour supplied Priyanka Harrichurran [email protected] 9  Principles of Macroeconomics ECON102 Why Labour Productivity Grows Physical Capital Growth o As the amount of capital per worker increases, labour productivity also increases Human Capital Growth o Human capital – the accumulated skill and knowledge of human beings – is the fundamental source of labour productivity growth o Human capital grows when a new discovery is made and it grows as more and more people learn how to use past discoveries Technological Advances o The discovery and the application of new technologies Priyanka Harrichurran [email protected] 10  Principles of Macroeconomics ECON102 Session 3: The Classical Model: Unemployment at Full Employment Reading: Parkin, 3rd ed., Ch 23 pp. 516 – 518; Ch 6 pp. 131-132 Parkin, 2nd ed., Ch 22 pp. 483-485; Ch 6 pp.124 -126 Key concepts The supply of labour Labour market equilibrium and potential GDP Unemployment at full employment Priyanka Harrichurran [email protected] 11  Principles of Macroeconomics ECON102 A Labour Market with a Minimum Wage A price floor is a regulation that makes it illegal to trade at a price lower than a specified level When a price floor is applied to labour markets, it is called a minimum wage If a minimum wage is set below the equilibrium wage, the minimum wage has no effect If a minimum wage is set above the equilibrium wage, the minimum wage is in conflict with market forces and does have some effects on the labour market Priyanka Harrichurran [email protected] 12  Principles of Macroeconomics ECON102 Inefficiency of a Minimum Wage The minimum wage frustrates the market mechanism and results in unemployment – wasted labour resources – and an inefficient amount of job search The minimum wage: o shrinks the firms’ surplus (blue triangle) o shrinks the workers’ surplus (green triangle) o creates a deadweight loss (grey triangle) o creates potential loss from people job searching (pink area) The minimum wage is unfair: o Unfair result: only those people who have jobs and keep them benefit from the minimum wage o Unfair rule: blocks voluntary exchange between firms and hhs Priyanka Harrichurran [email protected] 13  Principles of Macroeconomics ECON102 Session 4: Money and Banks Reading: Parkin, 3rd ed., Ch 26 pp.584-587 Parkin, 2nd ed., Ch 25 pp.545-548 Key concepts The definition and functions of money Measures of money in South Africa today Priyanka Harrichurran [email protected] 14  Principles of Macroeconomics ECON102 What is Money? Money is any commodity or token that is generally acceptable as a means of payment (method of settling debt) Money serves three other functions: o Medium of exchange  Any object that is generally accepted in exchange for goods and services  Overcomes the need for a double coincidence of wants (otherwise bartering has to take place) o Unit of account  an agreed measure for stating the prices of goods and services o Store of Value  Money is a store of value in the sense that it can be held and exchanged later for goods and services  If money were not a store of value, it could not serve as a means of payment Priyanka Harrichurran [email protected] 15  Principles of Macroeconomics ECON102 Money in South Africa Today Currency The notes and coins held by individuals and businesses Notes are money because the government declares them so with the signature of the Reserve Bank Governor Notes and coins inside the banks are not counted as currency because they are not held by individuals and business Deposits Deposits of individuals and businesses at banks and other depository institutions, such as the Postbank, are also counted as money Deposits are money because the owners of the deposits can use them to make payments Priyanka Harrichurran [email protected] 16  Principles of Macroeconomics ECON102 Money in South Africa Today Official Measures of Money M1: Consists of currency plus cheque deposits owned by individuals and businesses Does not include currency held by banks nor currency and cheque deposits owned by the government M2: Consists of M1 plus short-term and medium-term deposits (savings deposits and money market funds) M3: Consists of M2 plus money that is deposited for longer time horizons (like pension funds) All are Priyanka considered Harrichurran to be money - either consist of currency or cheque deposits which are a17 [email protected]  Principles of Macroeconomics ECON102 Class Exercise 4 Short Questions 1. Explain the concept of full employment. 2. Illustrate and label the labour market diagram. What does the labour market equilibrium determine? Explain the labour market equilibrium in the context of the aggregate production function. 3. Name and explain the three factors that determine labour productivity growth. 4. Name and explain the three main measures of money used in South Africa today. Priyanka Harrichurran [email protected] 18  Principles of Macroeconomics ECON102 Class Exercise 4 MCQ 1. If the real wage rate is R400 and the nominal wage rate is R8000, then the price level is: a) R20. b) R8000. c) R0.05. d) R3 200 000. e) R1. 𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑜𝑟 𝑚𝑜𝑛𝑒𝑦 𝑤𝑎𝑔𝑒 𝑟𝑎𝑡𝑒 𝑅𝑒𝑎𝑙 𝑤𝑎𝑔𝑒 𝑟𝑎𝑡𝑒= 𝑃 𝑟𝑖𝑐𝑒𝑙𝑒𝑣𝑒𝑙 Priyanka Harrichurran [email protected] 19  Principles of Macroeconomics ECON102 Class Exercise 4 MCQ 2. The aggregate production function is concave because _________. a) of decreasing returns to labour, as labour hours are not equally productive b) of increasing returns to labour, as labour hours are not equally productive c) the opportunity cost of labour is zero d) the marginal product of labour is constant e) the opportunity cost of labour is constant Priyanka Harrichurran [email protected] 20  Principles of Macroeconomics ECON102 Class Exercise 4 MCQ 3. Which of the following is an example of using money as a store of value? a) Paying for a computer with a government bond. b) Paying rent with a cheque on a demand deposit. c) Keeping R200 on hand for an emergency. d) Paying for a new dress with a credit card. e) Paying cash for a new automobile. Priyanka Harrichurran [email protected] 21