280 likes | 450 Views
Chapter 3: National Income. Production Function. Output of goods and services as a function of factor inputs Y = F(K, L) Y = product output K = capital input L = Labor input. Constant Returns to Scale.
E N D
Production Function • Output of goods and services as a function of factor inputs Y = F(K, L) • Y = product output • K = capital input • L = Labor input
Constant Returns to Scale • When an increase in the quantity of the inputs results in an equal increase in the quantity of the output F(zK, zL) = zY where z > 0
Supply of Products • Because we assume that the supplies of capital and labor inputs and the production technology are fixed, the supply of product output is also fixed Y = F(K, L) = Y
Input Price Determination • Input or factor prices are determined by the supply and demand for them. • Because we assume the input supply is fixed, its supply line is vertical. The factor demand curve is downward sloping. • The intersection of demand and supply determines the factor price.
Input Price Determination Price Supply Equilibrium price Demand Quantity
Profit Determination • Profit = Revenue – Labor Cost – Capital Cost П = PY – WL – RK P = price of output W = price of labor input = wage rate R = price of capital input = interest rate
Production Function Labor in the variable input Output F(K,L) MPL 1 MPL 1 MPL 1 Labor
Marginal Product of Inputs • Additional productivity gained from hiring an extra unit of the labor input. MPL and MPK are: MPL = F(K, L+1) – F(K, L) MPK = F(K+1, L) – F(K, L)
Diminishing Marginal Product of Labor As more labor input is added, holding capital input constant, the quantity of output will increase at a decreasing rate. Hence, MPL declines, due to inefficiency, as more labor is added. Units of output MPL Units of labor
The Firm’s Demand for Labor • Demand for labor depends on its price and marginal product In a competitive market: MPL = W/P = the real wage. The labor demand is W = P MPL
The Firm’s Demand for Capital • Demand for capital depends on its price and marginal product In a competitive market: MPK = R/P = the real interest. The capital demand is R = P MPK
Diminishing Marginal Product of Capital As more capital input is added, holding labor input constant, the output will increase at a decreasing rate. Hence, MPK declines, due to inefficiency, as more capital is added. Units of output MPK Units of capital
Determinants of Demand for Products • The GDP for a closed economy is total spending by households, firms, and government: Y = C + I + G Consumption = C Investment = I Government purchases = G
The Circular Flow on Income and Product Income Payments Labor Market Labor Resources Saving Investment Financial Market Households Firms Government Taxes Government Purchases Products Product Market Consumption Expenditures
Consumption Function • Consumption is a function of disposable personal income: C = C(Y – T) Y = personal income T = personal income taxes
Consumption Function • Marginal propensity to consume = additional consumption from an extra dollar of disposable personal income MPC = ΔC / Δ(Y –T) MPC is slope of consumption function.
Consumption Function Consumption, C C = C(Y – T) MPC 1 Disposable income, Y - T
Investment Function • Investment is a negative function of the real interest rate I = I(r) • Low interest rates encourage borrowing for investment purposes, whereas high interest rates discourage borrowing
Investment Function Real interest rate, r I(r) Quantity of investment, I
Government Role • We assume government purchases of goods and services and resources and personal income taxes are fixed amounts: G = G T = T
National Income Identity Y = C + I + G, where C = C(Y –T) I = I(r) G = G and T = T Y = C(Y – T) + I(r) + G
Saving Investment Identity • Equilibrium in the product market: Y = C(Y – T) + I(r) + G Y - C(Y – T) - G = I(r) S = I(r) Where S is national saving
Components of National Saving • Private saving: left over household income: Sp = Y – T – C • Public saving: left over government revenue: Sg = T – G
Determination of Real Interest Rate Real interest rate S Equilibrium interest rate I(r) Investment, Saving
Increase in Investment Demand Real interest rate An increase in investment demand results in a higher interest rate. S r2 r1 I’(r) I(r) Investment, Saving
Classical Saving Function • Saving is positively related to the real interest rate S = S(r) Real interest rate S(r) Quantity of Saving
Increase in Investment Demand Real interest rate S(r) r2 r1 I2 I1 Quantity of Saving I2 I1