Chapter 3 - Chapter 3 Long-Run Economic Performance How...

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Chapter 3: Long-Run Economic Performance How Much Does The Economy Produce? The Production Function There are many economic variables that influence the economy’s performance – the rate of consumer spending, value of the dollar, gyrations of the stock market, growth rate of the money supply Most basic determinant = economy’s physical capacity to produce G/S The amount of output that an economy produces depends on two factors: (1) quantities of input (capital goods, labour, raw materials, land, and energy) utilized in the production process - this is referred to as factors of production (2) the productivity of the inputs – that is the effectiveness with which they are used The effectiveness with which the capital and labour are used may be summarized by a relationship called the product function Production function: mathematical expression relating the amount of output produced to the quantities of capital and labour utilized Y t = A t F(K t , N t ) ; Y t = real output produced in the time period t A t = a number measuring the overall productivity of the economy in the time period t K t = the capital stock, or quantity of capital used in time period t N t = the number of workers employed in time period t F = a function relating output Y t to capital K t and labour N t According to the equation the amount of output Y that an economy can produce during any period of time depends on the size of the capital stock K and the number of workers N “A” is referred to as total factor productivity. If A increases by 10% then output will increase by 10%. Therefore, increases in A corresponds to improvements in production technology or to changes in the economy that allows capital and labour to be utilized more effectively Shape of Production Function The production function slopes upward from left to right – which tells us that as capital stock increases, more output can be produced Slope of production function becomes flatter from left to right – this property implies that although more capital always leads to more output, it does so at a decreasing rate Marginal Product of Capital MKP, is the increase in output produced resulting from a one-unit increase in the capital stock Marginal product of capital = change in Y/change in K Marginal product of capital is always positive (hence the upward slope) Marginal product of capital declines as the capital stock is increased (hence the slope becomes more flat) – this is known as diminishing marginal productivity Marginal Product of Labour MPN, is the additional output produced by each additional unit of labour = change in y/change in N
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Supply Shocks This is used to refer to a change in an economy’s production function A positive, or beneficial supply shock raises the amount of output that can be produced for given quantities of capital and labour A negative, or adverse, supply shock lowers the amount of output that can be produced
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This note was uploaded on 01/09/2011 for the course ECON 202 taught by Professor Angelatrimarchi during the Spring '10 term at Waterloo.

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Chapter 3 - Chapter 3 Long-Run Economic Performance How...

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