Full employment GDP is a hypothetical GDP level which an economy would achieve if it reported full employment. That is, it’s the GDP level corresponding to zero unemployment in the economy. By definition, full employment GDP is Pareto efficient, i.e., the economy can’t increase aggregate output without increasing the level of inputs. Since the economy is at full employment and all workers are working, the level of inputs can’t be increased further.
Full employment GDP is also the maximum Long Run level of GDP that can be sustained with the present technology level. Generally, full employment GDP refers to real GDP, i.e., GDP in terms of real goods and not in nominal terms.
Full Employment GDP is a hypothetical GDP level that an economy would achieve if it reported full employment, i.e., it is the GDP level corresponding to zero unemployment in the economy.
Full employment output level is always Pareto efficient, because mainstream economics models the production process as a synthesis between capital owners and laborers.
The points at the interior of the Production Possibility Frontier correspond to unemployment in the economy whereas the boundary of the Production Possibility Frontier corresponds to full employment in the economy.
Full Employment GDP and Complete Capital Utilization
A central tenet of mainstream economic theory is that capital is always completely utilized, i.e., there is never any unused capital in the economy. The theory follows directly from the neo-classical assumption of complete factor markets. If an economic agent owns capital but is not using it to produce output (i.e., add to the GDP), then the economic agent is forgoing capital rent. Since all economic agents are rational, no agent would willingly give up rent.
Therefore, there is never any spare capital in the economy. However, this does not mean that the capital in the economy is being used efficiently (capital could be stuck in inefficient industries). Complete capital utilization merely implies that every unit of capital in the economy is being used for production. Full employment output level is always Pareto efficient, because mainstream economics models the production process as a synthesis between capital owners and laborers.
The Production Possibility Frontier
The production possibility frontier is a graphical tool used to analyze production activities in an economy. Consider the following example: An economy produces and consumes only two goods: Cheese and Shoes. The economy could devote all its resources to cheese production or devote all its resources to shoe production, or pursue some combination of the two.
The total output in the economy (GDP) depends on production technology (how efficient is cheese production relative to shoe production), the total level of capital stock in the economy, and the total number of workers.
Full Employment Output vs. Natural Level of Output
The Natural Level of GDP is the GDP level corresponding to the natural rate of unemployment. The natural rate of unemployment is the average observed level of unemployment in the economy. An economy never achieves full employment) because of labor market frictions.
The two biggest sources of labor market frictions are frictions in the separation rate and frictions in the job finding rate. According to the Bureau of Labor Statistics, the natural rate of unemployment for the US economy is around 3.6% as of May 2019.
1. Separation Rate
The separation rate is the rate at which the average employed worker in the economy loses his job. A perfect labor market with complete information would see a very small separation rate (purely due to workers voluntarily leaving the labor force at the end of their careers). However, in the real world, due to problems caused by asymmetric information and imperfect labor contracts, the separation rate can be quite high.
2. Job Finding Rate
The job finding rate is the rate at which the average unemployed worker in the economy finds a job. A perfect labor market with complete information would see workers finding jobs instantly. However, in the real world, due to problems caused by asymmetric information and imperfect labor contracts, the job finding rate can be quite low.
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