Potential GDP and the Natural Unemployment Rate

Potential GDP and the Natural Unemployment Rate 8 CHECKPOINTS

Checkpoint 8.1 Checkpoint 8.2 Problem 1 Problem 1 Problem 2 Clicker version Problem 2 Problem 3 Problem 4

Practice Problem 1 Table 1 describes an economy’s production function and demand for labor. Table 2 describes the supply of labor in this economy. What are equilibrium employment, real wage rate, and potential GDP? CHECKPOINT 8.1

Solution The demand for labor is a graph of the first and third rows of Table 1. The supply of labor is a graph of the data in Table 2. CHECKPOINT 8.1

The production function is a graph of the first two rows of Table 1. CHECKPOINT 8.1

Labor market equilibrium occurs when the real wage rate is $30 an hour and 2 billion hours of labor are employed. Potential GDP is the real GDP produced by the equilibrium quantity of labor (2 billion hours in top figure). Potential GDP is $70 billion. CHECKPOINT 8.1

Practice Problem 2 Chevron signs $73b gas deal Gorgon, Chevron’s huge liquefied natural gas project, is finally going forward. The company, along with Exxon Mobil and Shell will produce natural gas off the northwest coast of Australia. Gorgon and surrounding fields hold an estimated 40 trillion cubic feet of natural gas, the equivalent of 6.7 billion barrels of oil. Gorgon is located for easy shipment to growing markets in China and India and at its peak will employ 10,000 workers. Source: Radio Australia, September 10, 2009 Explain how this huge project will influence Australia’s potential GDP and U.S. potential GDP. CHECKPOINT 8.1

Solution Accessing these new resources will shift Australia’s production function upward. With no change in employment, Australia’s real GDP would increase. But the project will increase the demand for labor, increase the full-employment quantity of labor, and increase potential GDP. CHECKPOINT 8.1

Even though this project is undertaken by U.S. firms, the production takes place in Australia. Neither the U.S. production function nor the U.S. demand for labor changes, so the project has no effect on U.S. potential GDP. Australia’s potential GDP will increase, but U.S. potential GDP will not change. CHECKPOINT 8.1

Practice Problem 1 During the past 50 years, Singapore has experienced rapid population growth has restructured its economy several times to remain at the forefront of the latest technology. Singapore has modest unemployment benefits, no minimum wage, and weak labor unions. Does the unemployment that Singapore experiences arise primarily from job search or job rationing? CHECKPOINT 8.2

Solution Singapore’s unemployment is likely to arise primarily from job search. Of the sources of job rationing (efficiency wages, minimum wages, and union wages) only efficiency wages applies. CHECKPOINT 8.2

Practice Problem 2 During the past 50 years, Singapore has experienced rapid population growth has restructured its economy several times to remain at the forefront of the latest technology. Singapore has modest unemployment benefits, no minimum wage, and weak labor unions. Which of these factors suggest that Singapore has a higher natural unemployment rate than the United States? Which of these factors suggest that Singapore has a lower natural unemployment rate than the United States? CHECKPOINT 8.2

Solution The factors that point toward a higher natural unemployment rate in Singapore than in the United States are Rapid population growth and restructuring to remain at the forefront of new technologies. Both these factors will create a large amount of job search, other things remaining the same. CHECKPOINT 8.2

The factors that point toward a lower natural unemployment rate in Singapore than in the United States are Modest unemployment benefits, which will limit the amount of job search, and The absence of a minimum wage and weak labor unions, which will limit the amount of job rationing. CHECKPOINT 8.2

Study Plan Problem Singapore has experienced rapid population growth, restructured its economy several times, and has modest unemployment benefits, no minimum wage, and weak labor unions. Unemployment in Singapore arises mainly from ______, but some ______ might arise from _______. A. job rationing; job search; minimum wages B. job rationing; job search; unemployment benefits C. job search; job rationing; efficiency wages D. job search; job rationing; minimum wages E. job search; job rationing; rapid population growth CHECKPOINT 8.2

Practice Problem 3 The figure illustrates the labor market in an economy in which at full employment, people spend 1,000 hours a day in job search. What is the full-employment equilibrium real wage rate and the quantity of labor employed? Calculate the natural unemployment rate. CHECKPOINT 8.2

Solution At full employment, the equilibrium real wage rate and the quantity of labor employed are determined by the demand for labor and the supply of labor. At full employment, the real wage rate is $3 an hour and 3,000 workers are employed. Unemployment is 1,000, so the labor force is 4,000. The natural unemployment rate equals(1,000 ÷ 4,000) × 100 = 25 percent. CHECKPOINT 8.2

Practice Problem 4 The minimum wage increases again A minimum wage increase provides a silver lining for part-time workers, as employers choose to promote more from within the firm than from outside. Low-skilled and youth workers who are employed gain, but for unemployed teenage workers, job prospects look grim. Source: laborlawcenter.com Explain why some part-time workers, low-skilled workers, and youth workers gain and why unemployed teenagers find it hard to get jobs. CHECKPOINT 8.2

Solution When the minimum wage rate is raised, firms retain those workers who produce at least as much output in an hour as the minimum wage rate. The job experience will help part-time and low-skilled employees retain their jobs, but teenagers with no experience will find it hard to get jobs. CHECKPOINT 8.2

Potential GDP and the Natural Unemployment Rate