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# ch%203 - MACROECONOMICS CHAPTE R 3 Natio nal Inc o me Whe...

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1 CHAPTER 3 National Income MACROECONOMICS C H A P T E R National Income: Where it Comes From and Where it Goes 3

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2 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
3 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

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4 CHAPTER 3 National Income The production function:  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
5 CHAPTER 3 National Income Returns to scale:  A review Initially Y1 = F ( K1 , L1 ) Scale all inputs by the same factor z : K2 = zK1 and L2 = zL1 ( e.g. , if z = 1.2, then all inputs are increased by 20%) What happens to output, Y2 = F ( K2 , L2 )? § If constant returns to scale , Y2 = zY1 § If increasing returns to scale , Y2 > zY1 § If decreasing returns to scale , Y2 < zY1

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6 CHAPTER 3 National Income Returns to scale:  Example 1 constant returns to scale for any z > 0 ( , ) F K L KL = ( , ) ( )( ) F zK zL zK zL = z KL = 2 z KL = 2 z KL = ( , ) zF K L =
7 CHAPTER 3 National Income Returns to scale:  Example 2 decreasing returns to scale for any z > 1 ( , ) F K L K L = + ( , ) F zK zL zK zL = + z K z L = + ( , ) z F K L = ( 29 z K L = +

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8 CHAPTER 1 The Science of Macroeconomics NOW YOU TRY:   Returns to Scale § Determine whether each of these production functions has constant, decreasing, or increasing returns to scale: (a) (b) ( , ) F K L K L = + ( , ) K F K L L = 2
9 CHAPTER 3 National Income Assumptions 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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10 CHAPTER 3 National Income Determining GDP Output is determined by the fixed factor supplies and the fixed state of technology: , = ( ) Y F K L
11 CHAPTER 3 National Income The distribution of national income § determined by factor prices , the prices per unit firms pay for the factors of production § wage = price of L § ren tal rate = price of K

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12 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
13 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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ch%203 - MACROECONOMICS CHAPTE R 3 Natio nal Inc o me Whe...

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