topic3.pdf - Macroeconomics 33040 Fall 2012 Topic 3 The Aggregate Production Function Loukas Karabarbounis University of Chicago Booth School of

topic3.pdf - Macroeconomics 33040 Fall 2012 Topic 3 The...

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Macroeconomics 33040 - Fall 2012 Topic 3: The Aggregate Production Function Loukas Karabarbounis University of Chicago, Booth School of Business
Production Function: Why Do We Care? Because it helps to understand the supply side of the economy. 1 How is GDP produced (product approach)? How is GDP divided among the factors of production (income approach)? 2 This tells us about the sources of economic growth why do countries grow? why some countries grow faster than others? what policies can improve long-run standards of living? 3 This tells us about the sources of business cycles how supply shocks cause economies to fluctuate around their long-run growth path? what policies can stabilize supply shocks? Topic 3 (Production Function) Macroeconomics 33040 - Fall 2012 2 / 36
1 Production Function: Inputs, Technology and Output 2 Properties of the Production Function 3 Productivity 4 Summary and Readings
Aggregate Production Function Definition Aggregate Production Function is a function that takes as input the factors of production and transforms them into output . Output: is the aggregate amount of goods and services that an economy produces in a given period of time (real GDP) Aggregate: This is the economy-wide output/GDP produced think of a representative firm operating the aggregate production function this is a good approximation under some conditions Inputs: physical capital, labor, raw material, land Topic 3 (Production Function) Macroeconomics 33040 - Fall 2012 3 / 36
The Inputs in the Production Function Y = AF ( K , N ) 1 Capital K (measured in dollars, like GDP) stock (capital) vs. flow (investment); K t +1 = (1 - δ ) K t + I t δ : depreciation rate of capital e.g.: machines, equipment, factories etc. 2 Labor N (total workers or total hours worked) N does not adjust for the quality of the workforce quality of workforce will be in A ; alternatively, we can use a third factor of production called “human capital” 3 Total Factor Productivity (TFP) or Technology A (unit free) measures the efficiency of combining capital with labor Topic 3 (Production Function) Macroeconomics 33040 - Fall 2012 4 / 36
Capital Accumulation Example ( K 0 = 10 and δ = 0 . 10) Period Capital in t-1 Undepreciated Capital Investment in New Capital Goods Capital in t= 1 10 9 11 Capital in t= 2 20 18 12 Capital in t= 3 30 27 13 Capital in t= 4 40 36 4 Capital in t= 5 40 36 14 Capital in t= 6 50 45 25 Capital in t= 7 70 63 …. Topic 3 (Production Function) Macroeconomics 33040 - Fall 2012 5 / 36
Total Factor Productivity (TFP): Examples Technical progress, RnD, Innovations. Quality of capital and labor. Utilization of capital. Deregulation in product markets. Infrastructure. Management practices and organizational capital. Misallocation of capital across firms and financial frictions. Any other factor of production not included in F ( K , N ) (e.g. energy or land). We think of increasing oil prices as lowering TFP.

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