Economics Chapter 21

the economy at full employment

Classical model -- models assume wages and prices adjust freely to changes in demand and supply
production function -- the relationship between the level of output and the factors of production
stock and capital -- a total of all the machines, equipment, and buildings in the entire economy
labor -- human effort, including both physical and mental effort, used to produce goods and services.
Real wage -- the wage paid to workers adjusted for changes in prices
substitution effect -- an increase in the wage will raise the opportunity cost of leisure and lead to an increase in hours worked
income effect -- as income rises, a worker may choose to work fewer hours in enjoyed more leisure
full employment output -- the level of output that results when the economy is producing at full employment
real business cycle theory -- the economic theory that emphasizes how shocks to technology can cause fluctuations in economic activity
crowding out -- the reduction in investment in the long run caused by an increase in government spending
closed economy -- an economy without international trade
open economy -- an economy with international trade
crowding in -- the increase of investment in the long run caused by decrease in government spending

Notes

Full employment or potential output is the level of GDP produced from a given supply of capital when the labor market is in equilibrium. Potential output is fully determined by the supply of factors of production in the economy.

Increases in the stock of capital raise the level of full employment output and real wages.
Increases in the supply of labor will raise the level of full employment output but lower the level of real wages.

The full employment model has many applications. Many economists use it to study the effects of taxes on potential output. Others have found it useful in understanding economic fluctuations.
At full employment, increases in government spending less come at the expense of other components of GDP. In a closed economy, either consumption or investment must be crowded out. In an open economy, net exports can be crowded out as well. Decreases in government spending will crowd and other types of spending.