Chapter3

# Chapter3 - Chapter3 National Income: Where it Comes From...

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slide 1 Chapter 3 National Income: Where it Comes From and Where it Goes CHAPTER 3 National Income

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slide 2 CHAPTER 3 National Income In this chapter, you will learn… what determines the economy’s 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 Outline of model A closed economy, market-clearing 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

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slide 4 CHAPTER 3 National Income Factors of production K = capital: tools, machines, and structures used in production L = labor: the physical and mental efforts of workers
slide 5 CHAPTER 3 National Income The production function denoted Y = F ( K , L ) shows how much output ( Y ) the economy can produce from K units of capital and L units of labor reflects the economy’s level of technology exhibits constant returns to scale

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slide 6 CHAPTER 3 National Income Returns to scale:  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 )? If constant returns to scale , Y 2 = zY 1 If increasing returns to scale , Y 2 > zY 1 If decreasing returns to scale , Y 2 < zY 1
slide 7 CHAPTER 3 National Income Assumptions of the model 1. Technology is fixed. 2. The economy’s supplies of capital and labor are fixed at and K K L L = =

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slide 8 CHAPTER 3 National Income Determining GDP Output is determined by the fixed factor supplies and the fixed state of technology: , = ( ) Y F K L
slide 9 CHAPTER 3 National Income The distribution of national income determined by factor prices , the prices per unit that firms pay for the factors of production wage = price of L ren tal rate = price of K

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slide 10 CHAPTER 3 National Income Notation W = nominal wage R = nominal rental rate P = price of output W / P = real wage (measured in units of output) R / P = real rental rate W = nominal wage R = nominal rental rate P = price of output W / P = real wage (measured in units of output) R / P = real rental rate
slide 11 CHAPTER 3 National Income How factor prices are determined Factor prices are determined by supply and demand in factor markets. Recall: Supply of each factor is fixed. What about demand?

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CHAPTER 3 National Income Demand for labor Assume markets are competitive: each firm takes W , R , and P as given. Basic idea:
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## This document was uploaded on 10/28/2011 for the course ECON 420 at UNC.

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Chapter3 - Chapter3 National Income: Where it Comes From...

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