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14.02_Lectures_3-4

14.02_Lectures_3-4 - TOPIC TOPIC 2 The Supply Side of the...

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TOPIC 2 Th S l Sid f h E The Supply Side of the Economy
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Goals of Topic 2 Introduce the Supply Side of the Macro Economy: 1. Production Function 2. Labor Market: Labor Demand Labor Supply Equilibrium Wages and Employment 2
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Production Function
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The Production Function GDP (Y) is produced with capital ( K ) and labor ( N ): Y = A F(K,N) Y A F(K,N) where A is Total Factor Productivity ( TFP ) = an index of efficiency in the use of inputs ( technology ) Sometimes, I will modify the production function as follows: Y = A F(K,N, other inputs) where other inputs include energy/oil! Realistic Example is a Cobb Douglas function for F(.): Y =A K α N 1- α 4 with 0< α <1
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Measurement Y is GDP (it is measured in dollars). As noted above, we want to measure Y in “real” terms.<<you should know what this means from lecture 2>>. For our Cobb Douglas production function, N is measured in number of workers and K in dollars: K often is measured as the replacement cost of capital N often is measured in number of workers N can also be measured using total hours worked = number of workers × hours per worker Wage differentials can help to measure “effective labor supply”, taking into account “skill” differentials. 5 N.B.: sometimes we will use N to denote total population (e.g. income per capitaY/N)
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Graphical Representation 1 Hold A and N constant (at levels A* and N*) Graph Y as a function of K Y A*F(K,N*) K 1. As K increases Y increases (the curve is upward-sloping ) 2 A K i th i l i i d ti d (th 6 2. As K increases the marginal increase in production decreases (the curve becomes flatter as K increases )
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Graphical Representation 2 Hold A and K constant (at levels A* and K*) Graph Y as a function of N Y A*F(K*,N) N 1. As N increases Y increases (the curve is upward-sloping ) 2 A N i th i l i i d ti d (th 7 2. As N increases the marginal increase in production decreases (the curve becomes flatter as N increases )
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Aggregate Production Function: Fact 1 1. Constant Returns to Scale FACT 1: If you double the inputs, you double the output! 2Y = AF(2K,2N) 2Y AF(2K,2N) Cobb-Douglas: 2Y = A (2K) α (2N) 1- α = 2A K α N 1- α (2N) 2A K N CRUCIAL: α + (1- α ) = 1! 8
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