The Dynamic Classical Model

1. The Dynamic Classical Model • Changes in Productivity • Labor productivity is real GDP per hour of labor. • Three factors influence labor productivity. • Physical capital • Human capital • Technology

2. The Dynamic Classical Model • Human capital is the knowledge and skill that has been acquired from education and on-the-job training. • Learning-by-doing is the activity of on-the-job education that can greatly increase labor productivity.

3. The Dynamic Classical Model • Shifts in the Production Function • Any influence that increases labor productivity increases real GDP at each level of labor hours and shifts the production function upward. • An increase in physical capital, human capital, or a technological advance all increase labor productivity.

4. The Dynamic Classical Model • Figure 8.10 illustrates in increase in labor productivity. The production function shifts upward from PF0 to PF1.

5. The Dynamic Classical Model • Two factors that increase potential GDP are • An increase in population • An increase in labor productivity

6. The Dynamic Classical Model • An Increase in Population • An increase in population increases the supply of labor. • The equilibrium real wage rate falls and the equilibrium quantity of labor increases. • The increase in the equilibrium quantity of labor increases potential GDP. • The potential GDP per hour of work decreases.

7. The Dynamic Classical Model • Figure 8.11(a) illustrates these effects in the labor market.

8. The Dynamic Classical Model • Potential GDP increases. • Potential GDP per hour of work decreases. • Initially, potential GDP per hour of work was $50--$10 trillion divided by 200 billion. • In the new equilibrium, potential GDP per hour of work is $43.33--$13 trillion divided by 300 billion.

9. The Dynamic Classical Model • An Increase in Labor Productivity • Three factors increase labor productivity • An increase in physical capital • An increase in human capital • An advance in technology • An increase in labor productivity shifts the production function upward and increases the demand for labor. • The equilibrium real wage rate, quantity of labor, and potential GDP all increase.

10. The Dynamic Classical Model • Figure 8.12(a) illustrates these effects. • The labor demand curve shifts rightward. • The real wage rate rises. • The equilibrium quantity of labor increases.

11. The Dynamic Classical Model • Figure 8.12(b) shows the change in the production function. • The production function shifts upward and the quantity of labor employed increases. • Both changes increase potential GDP.

12. The Dynamic Classical Model • Population and Productivity in the United States • Population and productivity in the United States have increased over time. • Between 1981 and 2001, both years close to full employment: • The working age population increased from 170 million to 212 million–a 25 percent increase. • Labor hours increased from 159 billion to 231 billion—a 45 percent increase.

13. The Dynamic Classical Model • Population and productivity in the United States have increased over time. • Between 1981 and 2001, both years close to full employment: • The capital stock increased from $15 trillion (1996 dollars) to $25 trillion—a 67 percent increase. • Technology advanced—most notably the information revolution and the widespread computerization of production processes.

14. The Dynamic Classical Model • The percentage increase in labor hours exceeded the percentage increase in the population because the increase in capital and technological advances increased labor productivity, which increased the real wage rate, which in turn increased the labor force participation rate.