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Unformatted text preview: slide 1 CHAPTER 3 National Income Chapter 3 National Income: Where it Comes From and Where it Goes slide 2 CHAPTER 3 National Income In this chapter, you will learn What determines the economys total output/income. How the prices of the factors of production are determined. How total income is distributed. What determines the demand for goods and services. How equilibrium in the goods market is achieved. slide 3 CHAPTER 3 National Income A closed economy An economy in autarky. No trade with the rest of the world slide 4 CHAPTER 3 National Income Outline of model A closed economy, marketclearing 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. slide 5 CHAPTER 3 National Income Factors of production Assume 2 factors of production: K = Capital: Tools, machines, and structures used in production. L = Labour: The physical and mental efforts of workers. slide 6 CHAPTER 3 National Income The production function Denoted Y = F ( K , L ). Shows maximum output ( Y ) the economy can produce given K units of capital and L units of labour. Reflects the economys level of technology. We will assume it exhibits constant returns to scale. slide 7 CHAPTER 3 National Income Homogeneity If we can write f ( zx ) = z k f ( x ) We say f ( x ) is homogeneous of degree (HOD) k . slide 8 CHAPTER 3 National Income A review Initially Y 1 = F ( K 1 , L 1 ) Scale all inputs by the same factor z : K 2 = zK 1 and L 2 = zL 1 ( e.g. , if z = 1.25, then all inputs are increased by 25%) What happens to output, Y 2 = F ( K 2 , L 2 )? slide 9 CHAPTER 3 National Income Constant Returns to Scale If constant returns to scale , Y 2 = zY 1 In other words: Y 2 = F (z K 1 ,z L 1 ) = z 1 F ( K 1 , L 1 ) = zY 1 slide 10 CHAPTER 3 National Income Example 1 ( , ) F K L KL = ( , ) ( )( ) F zK zL zK zL = z KL = 2 z KL = 2 z KL = ( , ) zF K L = constant returns to scale for any z > 0 slide 11 CHAPTER 3 National Income Decreasing Returns to Scale (DRTS) If decreasing returns to scale , Y 2 < zY 1 In other words: Y 2 = F (z K 1 ,z L 1 ) = z k F ( K 1 , L 1 ) = z k Y 1 k < 1 slide 12 CHAPTER 3 National Income Example 2 ( , ) F K L K L = + ( , ) F zK zL zK zL = + z K z L = + ( , ) z F K L = decreasing returns to scale for any z > 1 ( 29 z K L = + slide 13 CHAPTER 3 National Income Increasing Returns to Scale (IRTS) If increasing returns to scale , Y 2 > zY 1 In other words: Y 2 = F (z K 1 ,z L 1 ) = z k F ( K 1 , L 1 ) = z k Y 1 k > 1 slide 14 CHAPTER 3 National Income Example 3 ( , ) F K L K L = + 2 2 ( , ) ( ) ( ) F zK zL zK zL = + 2 2 ( , ) z F K L = 2 increasing returns to scale for any z > 1 ( 29 z K L = + 2 2 2 slide 15 CHAPTER 3 National Income Now you try Determine whether constant, decreasing, or increasing returns to scale for each of these production functions: (a) (b) ( , ) F K L K L = + ( , ) K F K L L = 2 slide 16...
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 Spring '10
 AngelaTrimarchi
 National Income

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