LABOR

Not everybody in the populations is in the labor force. It is against the law for children to work ; many adults are in school, working at home, or in retirement ; quite a few others are unable to work because they are disable or sick. Some people are committed to working full time no matter what the incentives provided by the labor market.

We define potential employment as the volume of employment that the entire population would choose given existing incentives. It is the total amount of work that would be done if every body could fined a job and earn as much as people like themselves are already earning. Notice that potential employment is  not the absolute maximum amount of work that the population is capable of doing. It is the amount they would want to do given the existing real wage, which, as we saw in Chapter 3, measures the purchasing power of wages. The real wages is the actual wage paid, w, divided by the price level, P. Potensial employment might rise if the real wage increased.

In our analysis potential employment does not depent on any of the major macro variables : output, consumption, investment, the interest rate, or the price level. It is exogenous. Though potential employment depends on the real wage W / P, it does not depend on the price level P.  The reason is that actual wages are assumed to vary in proportion to the price level, so that a change in the price level does not affect the real wage. This is a fairly realistic assumption for short-run macroeconomic fluctuations. Potential employment is not fixed, however. It grows steadily as the population grows.