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Profit Maximization = working at all (the alternative being starvation)We also said that this would always be the sad truth, as long as there was unemployment. And, of course, unemployment seems always to be with us. In the next three lessons we will indulge our curiosity about why that is so, and what -- if anything -- can be done about it. In other words, we'll be talking about the business cycle.
Marginal Cost = subsistence (because competition will always undercut any higher price)
Businesses hire workers as long as it is profitable for them to do so. We wouldn't expect them to keep hiring workers past their point of diminishing returns, would we? Hire workers to just stand around and get in each other's way? No, we want businesses to be competitive; we want them to hire the workers they need. We want them to be lean, mean maximizing machines. But, when we do it that way, some workers are left out. Why are there no jobs for them?
Has the economy produced enough goods and services to satisfy everyone's desires? No way -- because human desires are unlimited. We always find something else to want. So: what's needed for production to take place? Things get produced when labor (that we've got plenty of) uses capital (very, very useful, but not completely necessary) on land (absolutely necessary). (It might be useful to add that things get produced when there is demand for them. Demand is desire backed up by the ability to pay for stuff.)
All right, so why, then, should labor be unemployed? There's no shortage of desires to satisfy. Why can't every person willing and able to work find land to work on and capital to work with? Why can't we send our unemployment rate down to zero?
All right: so let's move in that direction. Let's think about what happens when the economy is going great guns, more people are working, producing more stuff, increasing demand. For a while, it's pretty easy to meet the increased demand without having to increase prices much: factories just produce more, right up to their full capacity. But: what happens when demand continues to increase? That will tend to drive prices up at a faster rate than output is increasing. In other words, it'll leads to inflation.
In brief, here is how that works: As demand goes up, producers reach a point at which it becomes more expensive to meet the demand, because producers' existing stock of land, labor and capital is maxed out, and they must invest in more of it. So they do this, and raise their prices. But demand is still high -- and they need labor to keep increasing their output. So, competition for workers bids up the price of labor to meet the increased prices of goods. This self-reinforcing process is sometimes called an inflation spiral. Generally, this process will intensify, until demand slows down. Then, production will ease up and -- you guessed it -- unemployment will rise again!
To make a long story short: there appears to be a point beyond which the economy cannot hire more people to produce more stuff, because doing so would lead to an unacceptably severe rise in prices. There must be a point, then, at which we have the highest possible number of people working without creating too much inflation. Economists call that level of production the potential output of the economy at any given time. The level of employment that exists at the economy's potential output is called the full employment point. (It is also called the Non-Accelerating Inflation Rate of Unemployment, or NAIRU.)
But remember! Because of the problem of inflation, "full employment" does not mean that everyone who wants a job can find one! Full employment in the US has hovered in the range of five to six per cent unemployed for the last three decades.
This fact becomes even more significant, if we know a bit about how unemployment is defined and counted. For the US government's counting purposes, a person is employed if he or she has worked for pay for any time at all, even just one hour, during the past week. A person is unemployed if he or she has not worked for pay during that time but has actively sought work. People who have neither been working nor seeking work are defined as "outside the labor force". Using these definitions, the US Department of Labor puts the current unemployment rate (January, 2003) at 6%, and the "labor force participation rate" at about 66%. This means that a very sizable percentage of the adult population is not working for a living. If -- according to standard macroeconomic theory -- we were to put very many of these people to work, inflation would shoot through the roof.
Background Questions
- What is the difference between demand and desire?
- When demand for goods increases past suppliers' existing full capacity to supply them, what happens? Why?
- Why are some workers unable to find jobs during a period of "full employment"?
- How is "employment" defined in terms of nation unemployment statistics?
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