Professional Documents
Culture Documents
Lecture Slides Chap03
Lecture Slides Chap03
Lecture Slides Chap03
Chapter 3
National Income
1
Outline of model
A closed economy, market-clearing model
Supply side
factor markets (supply, demand, price)
determination of output/income
Demand side
determinants of C, I, and G
Equilibrium
goods market
loanable funds market
CHAPTER 3 National Income 2
Factors of production
K = capital:
tools, machines, and structures used in
production
L= labor:
the physical and mental efforts of
workers
F (K , L) KL
F (zK , zL) (zK )(zL)
z 2KL
z 2 KL
z KL
constant returns to
z F (K , L)
scale for any z > 0
F (K , L) K 2 L2
z 2 K 2 L2
2 increasing returns
z F (K , L)
to scale for any
z>1
𝐹 𝐾, 𝐿 = 𝐾 0.5 + 𝐿0.5
𝐹 𝑧𝐾, 𝑧𝐿 = (𝑧𝐾)0.5 + (𝑧𝐿)0.5
9
NOW YOU TRY
Answers, Part (a)
K2
F (K , L)
L
(zK )2 z 2K 2 K2
F (zK , zL) z
zL zL L
z F (K , L)
constant returns to
scale for any z > 0
10
NOW YOU TRY
Answers, Part (b)
F (K , L) K L
F (zK , zL) zK zL
z (K L)
z F (K , L) constant returns to
scale for any z > 0
11
Assumptions
1. Technology is fixed.
2. The economy’s supplies of capital and labor
are fixed at:
K K and LL
Y F (K , L )
W = nominal wage
R = nominal rental rate
P = price of output
W /P = real wage
(measured in units of output)
R /P = real rental rate
10
0
0 1 2 3 4 5 6 7 8 9 10
Labor (L)
20
MPL and the production function
Y
output As more labor is
added, MPL falls
F (K , L )
MPL
1
MPL
1
a) F (K , L) 2K 15L
b) F (K , L) KL
c) F (K , L) 2 K 15 L
23
ANSWERS
Identifying diminishing returns
a) F (K , L) 2K 15L
𝜕𝐹 𝐾, 𝐿
= 15
No, MPL = 15 for all L 𝜕𝐿
b) F (K , L) KL 𝜕𝐹 𝐾, 𝐿 1 𝐾
=
𝜕𝐿 2 𝐿
Yes, MPL falls as L rises
c) F (K , L) 2 K 15 L 𝜕𝐹 𝐾, 𝐿
=
15 1
𝜕𝐿 2 𝐿
Yes, MPL falls as L rises
24
NOW YOU TRY
MPL and labor demand L Y MPL
0 0 n.a.
Suppose W/P = 6. 1 10 10
2 19 9
If L = 3, should firm hire
3 27 8
more or less labor? Why?
4 34 7
If L = 7, should firm hire 5 40 6
more or less labor? Why? 6 45 5
7 49 4
8 52 3
9 54 2
10 55 1
25
ANSWERS
MPL and labor demand L Y MPL
0 0 n.a.
If L = 3, should firm hire more or less 1 10 10
labor? 2 19 9
Answer: MORE, because the benefit 3 27 8
of the 4th worker (MPL = 7) exceeds 4 34 7
its cost (W/P = 6) 5 40 6
6 45 5
If L = 7, should firm hire more or less
labor? 7 49 4
8 52 3
Answer: LESS, because the 7th
9 54 2
worker adds MPL = 4 units of output
10 55 1
but costs the firm W/P = 6.
26
MPL and the demand for labor
Units of
output Each firm hires labor
up to the point where
MPL = W/P.
Real
wage
MPL,
Labor
demand
Units of labor, L
Quantity of labor
demanded
Equilibrium
real wage MPL,
Labor
demand
L Units of labor, L
equilibrium
R/P MPK,
demand for
capital
K Units of capital, K
Y MPL L MPK K
0.6
0.5
0.4
Labor’s share of income
0.3
is approximately constant over time.
0.2 (Thus, capital’s share is, too.)
0.1
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
The Cobb-Douglas production function
The Cobb-Douglas production function has
constant factor shares:
α = capital’s share of total income:
capital income = MPK × K = αY
labor income = MPL × L = (1 – α )Y
The Cobb-Douglas production function is:
1
Y AK L
where A represents the level of technology.
1 1 Y
MPK AK L
K
(1 )Y
MPL (1 ) AK L
L
0.40
Gini coefficient
0.35
0.30
Explanations for rising inequality
1. Rise in capital’s share of income, since capital
income is more concentrated than labor income
2. From The Race Between Education and
Technology by Goldin & Katz
Technological progress has increased the
demand for skilled relative to unskilled workers.
Due to a slowdown in expansion of education,
the supply of skilled workers has not kept up.
Result: Rising gap between wages of skilled and
unskilled workers.
Demand side
Next determinants of C, I, and G
Equilibrium
goods market
loanable funds market
C (Y –T )
Y–T
r
Spending on
investment goods
depends negatively on
the real interest rate.
I (r )
G G and T T
Aggregate supply: Y F (K , L )
Equilibrium: Y = C (Y T ) I (r ) G
r
The investment
curve is also the
demand curve for
loanable funds.
I (r )
Private saving = (Y – T ) – C
Public saving = T–G
National saving, S
= private saving + public saving
= (Y –T ) – C + T – G
= Y–C–G
53
ANSWERS
Calculate the change in saving
S Y C G Y 0.8(Y T ) G
0.2 Y 0.8 T G
a. S 100
b. S 0.8 100 80
c. S 0.2 100 20
d. Y MPL L 20 10 200,
S 0.2 Y 0.2 200 40.
54
Budget surpluses and deficits
0
Percent of GDP
-5
-10
-15
-20
-25
-30
-35
1940 1950 1960 1970 1980 1990 2000 2010
U.S. federal government debt,
1940-2016
140
120
100
Percent of GDP
80
60
40
20
0
1940 1950 1960 1970 1980 1990 2000 2010
Loanable funds supply curve
r S Y C (Y T ) G
National saving
does not
depend on r,
so the supply
curve is vertical.
S, I
Equilibrium real
interest rate
I (r )
Equilibrium level S, I
of investment
S Y C (Y T ) G
G S T C S
r2
2. …which causes
the real interest
r1
rate to rise…
3. …which reduces I (r )
the level of I2 I1 S, I
investment.
65
NOW YOU TRY
The effects of saving incentives
1. The rightward r S1 S2
shift in saving…
2. …which causes
the real interest r1
rate to fall…
r2
3. …which I (r )
increases the
level of S, I
investment.
CHAPTER 3 National Income 66
Mastering the loanable funds model
(continued)
Things that shift the investment curve:
some technological innovations
to take advantage of some innovations,
firms must buy new investment goods
tax laws that affect investment
e.g., investment tax credit
r S (r )
An increase in
investment demand
raises r,
which induces an r2
increase in the
r1
quantity of saving,
which allows I
to increase. I(r)2
I(r)
I 1 I2 S, I
71
CHAPTER SUMMARY
72
CHAPTER SUMMARY
73