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notes_on_production

# notes_on_production - I Overview When dealing with growth...

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Page 1 of 8 I. Overview When dealing with growth, we need to pay a lot of attention to the aggregate production function which represents the supply side of the economy. Eventually, we need to balance the demand side of the economy (what people buy : Y = C + I + G + NX ) with what firms produce ( Y = some production function ). But, before we get there, we need to know how firms produce. Measuring the supply side of the economy has been the subject of much active research in macroeconomics during the last two decades. In this class, we specify one aggregate production function for the economy. In the real world, each firm has its own production function. Ford takes some inputs and mixes them with some technology to make a product; Honda also takes some inputs and mixes them with some technology to make a product. Both make cars. But, Ford may use more labor to make cars and Honda may use more assembly lines - in the end, they both make cars. We assume that there is only one 'production function' (defined below) for the ‘aggregate’ economy. Recent research has tried to relax this assumption - it is very difficult to do. But, assuming one production function still allows our models to have high predictive power. As we will see, our aggregate production function matches the aggregate data well AND has all the qualitative predictions that we believe any individual firm specific production function should have. II. Some Preliminaries A production function is a mathematical relationship between the inputs a firm uses and the output the firm generates. We are going to assume that the firm only uses three broad inputs: labor (workers), capital (machines) and some technology (we are going to abstract from things like raw materials and land as of now - if it makes you more comfortable, we will include these in our measure of capital). You should think of capital as ECONOMIC CAPITAL. Economic capital is simply the integral of all past investment - net of depreciation. That means if you bought a machine this year - it is investment this year. But, that machine also adds to the 'capital stock'. The capital stock is the value of all existing machines that your firm owns. Note: We often measure labor and capital like we measure output - in terms of dollars. Our measure of labor, then, is the 'real' value of wages paid to workers and our measure of capital is the ‘real’ value of machines that we use. We could also measure labor in terms of workers or in terms of # of hours worked. An aggregate production function can look something like: Y = AF(K, L) where F(.) is some mathematical relationship (a function), K is our symbol for the capital stock , L is our symbol for labor and A is our symbol for our technology measure. This is a production function!!!!!

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notes_on_production - I Overview When dealing with growth...

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