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101_F07_HO_3 - ECN 101 Shaofeng Xu Fall 07 Handout 3 Income...

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ECN 101 Fall 07 Shaofeng Xu Handout 3: Income Distribution and Savings Oct 14, 2007 1. Income Distribution The theory of income distribution, simply speaking, centers on the determi- nation of the input quantity in production. In other words, given prices of labor and capital, the °rm has to make a decision on how many workers it will em- ploy and how much capital it will rent based on the principle of MAXIMIZING PROFIT. After then, workers and capitalists get paid which naturally leads to a distribution of income in the economy. Now we consider the principle of input usage. The °rm, always acts as a pro°t maximizer, faces the following problem: Max P ° F ( K; L ) ± W ° L ± R ° K where °rm has to choose K&L. In order to solve this problem, we just have to take derivatives with respect to K and L respectively. We then have the following conditions: P ° MPL ± W = 0 ) MPL = W P (1) P ° MPK ± R = 0 ) MPK = R P (2) (1) implies that when considering the amount of labor to be employed, the
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