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## AP®︎/College Macroeconomics

# Changes in the aggregate production function

AP.MACRO:

MEA‑2.A (LO)

, MEA‑2.B (LO)

, MEA‑2.B.5 (EK)

The factors that contribute to aggregate production include the labor force, capital, and technology. When these factors increase, they can lead to an increase in production. Additionally, productivity, or output per person, is another important metric to consider.

## Want to join the conversation?

- At0:47, Sal says that increased velocity of money does not increase output.

However, in a previous lesson we learned that money velocity (V) is related to money supply (M), price level (P), and real GDP (Y) through the formula M*V = P*Y.*All else equal*means that we need to fix M and P. So when V increases, real GDP (and therefore output) has to increase. Why is this wrong?(3 votes) - If the unemployment rate increases, is that a shift down in the aggregate production function or a move down and to the left along the production function?(1 vote)
- Assuming all else is constant (capital and technology are not changing), then it is a movement
**along**the aggregate production function to the left. A production function shows the value of output given inputs, so an increase in unemployment is associated with a movement along the curve (less labor being used to make less output).

A shift of the entire curve would mean that given the same amount of labor (i.e., no change in employment) you produce less.(2 votes)

## Video transcript

- [Instructor] So we are
posed with the question, All else equal, which of the
following would likely cause aggregate production to go up? Pause this video, and see which of these
you think would do that. All right, now let's work
through this together. This first one says, More people enter the labor force while the unemployment
rate stays constant. Well, labor is an important
factor of production. And if more people enter the labor force, and the unemployment rate stays the same, that means that the absolute number of people who are working goes up. And if everything else stays constant, the level of technology, the capital, the productivity per person, well, then you would expect
to be able to produce more. So aggregate production
should go up in this scenario. So I'll put a check right over there. The second one, Velocity of money goes up. This one is tempting, because you might associate
a high velocity of money, there's a lot of transactions going on, you might associate that
with a very positive economy, but remember, we're saying all else equal. There might be a scenario where, people are transacting more, there's more, the money is circulating faster, but the total amount of
output hasn't changed at all. There's the same number of people producing the same amount of goods, using the same technology
and the same capital. And so this does not have a direct linkage to the output going up, all else equal. So I'll rule this out. Inflation goes up. Well this, again, is tempting, because many times, when we
are producing at a high rate, when the economy is strong, that's associated with higher inflation. But there's many cases in history where you might even have hyper-inflation when the economy is
actually even shrinking. And remember, we're saying all else equal. So there's a situation
where the price level, and the rate of the price
level going up, is going up, but we're producing the same
amount of goods and services. And so I will rule this out. A new method of producing more goods with the same resources is developed. Well just imagine a very simple scenario. If the whole economy consists
of me, and I produce pencils, and let's say I can
produce 10 pencils a day, but I just have a new method
of producing 20 pencils a day, with the same resources, with just me, and the same access to
wood, and the same tools, well that's gonna dramatically increase my aggregate production. So one way to think
about it is this is our, our level of technology has gone up, which is an important
factor of production. So I like that one. Ten new farms are constructed. Well, if the farms are constructed, and I will assume that they are used, well we're going to have more output. They're gonna grow more things. Our level of capital has gone up. Once again, another important
factor of production. So I like that. Imports go up. Well imports are us taking advantage, or using someone else's output. It doesn't say what it's
going to do to our output. So I will rule that out. And so this is quite intuitive. We've talked about factors of production, like labor, and capital, and technology. And economists often tie this together, taking these factors of production, and showing how they lead
to our aggregate output by using something known as the Aggregate Production Function. Aggregate, Aggregate Production, Function. And it's a fancy set of words. And what I'm about to write
seems like fancy math, but as we'll hopefully see,
it's reasonably intuitive. The Aggregate Production Function is that our output is equal to A, which, you could use a
measure of our technology. It's often known as Total
Factor Productivity, another fancy word, times a function of, that's why it's fancy, it's
using the function notation, of our capital, and I know
capital does not start with K in the English language, but
K for capital, and our labor. And this is all very abstract. If we wanted to make it a
little bit more tangible, especially 'cause we just have
function notation in here, we could say something like, our aggregate output,
our aggregate production, is equal to our Total Factor Productivity, and then I'll make up a version of this. Let's say, times the
square root of our capital, times the square root of our labor. But in general, and as
you see in this example, you're going to see Aggregate
Production Functions that look something like this. The radicals, or the square
roots on capital and labor might be a little bit different, but they tell the same story, that if you increase
your level of technology, you're going to increase
your aggregate output. If you increase your capital, you're going to increase
your aggregate output. And if you increase your labor, you're going to increase
your aggregate output. The reason why you might see square roots, or fractional exponents
on capital or labor is this idea of diminishing
marginal returns. That first farm might really
add a lot to your output, but maybe that millionth farm might still add to your output, but maybe at a less
level, at a lower level. Same thing, that first,
those first 10 people might add a lot of output to your labor, but after you already
have 100 million people, the next 10 will still add to
your output, but maybe less. At least that's what these
mathematical models are saying. So big picture, it's pretty intuitive that if you hold everything else equal, and if you increase the factors
of production, well then, that would likely cause your
aggregate production to go up. But economists like to
describe things mathematically, and that's what's going on in something like an Aggregate Production Function. Now last but not least, a related idea to an Aggregate Production Function is this idea of productivity. Pro-duc-tivity. We already viewed A as
Total Factor Productivity, but it's really a measure of
the technology in an economy. Typically, when people talk
just about regular productivity, they're talking about output
per capita, output per person. So really, what they're doing is, they're thinking about
aggregate production, so Y, and then they're dividing it by labor. So then they would divide it by labor. So this would be output per person. And so you could imagine,
if technology improves, holding labor constant, well then your output per
person is going to improve. If your capital goes up, which
would improve your output, holding labor constant, then once again, your
productivity would improve. Per person, you're able to
produce more in your economy.