slide_3 - National Income: Where It Comes From and Where It...

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National Income: Where It Comes From and Where It goes (Chapter 3) Basic Classical Model January 25, 2012
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1 Classical Theory First introduction to a simple classical theory Classical models are used for long run analysis Two Assumptions: Flexible prices ! Markets clear instantaneously Perfect Competition: no market power by any individual &rm (or house- hold)
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2 This chapter: a basic classical model Closed economy - NX is dropped Only concered about real variables - Why not consider nominal and real variables simultaneously?
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3 What we want to know? 1. What determines the total output/income (i.e. the level of real GDP) 2. How the prices of factors of production are determined 3. How total income is distributed (to labor and owners of capital) 4. What determines how GDP is allocated to C , I and G 5. What determines the demand for goods and services 6. How the equilibrium of goods, factors, and &nancial markets are achieved
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4 Two additional objectives from this chapter 1. To be familiar with some of the basic terms and concepts that will be used throughout the book - production function, consumption function, and investment function - marginal product of labor ( MPL ), marginal product of capital ( MPK ) - constant/decreasing/increasing returns to scale 2. To develop a "benchmark model" - basis for more complicated models - Open economy model (ch 5), Solow growth model (ch 7, 8), Keynesian model (ch 10, 11)
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5 Outline of the Model Supply Side (Production) Determination of Output/Income, Y Factor Markets (Supply, Demand, Price): K , L Demand Side (Expenditure) Determinants of C , I , G Equilibrium Goods (and Services) markets Financial markets (Loanable Funds markets)
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6 Three Players in the Model Households : (workers + capitalists) - Receive income by supplying L and K in factors markets - Make consumption ( C ) in goods (and services) markets - Pay taxes ( T ) to government - Save and supply the saving ( S p ) in &nancial markets - Make investment ( I ) using the fund obtained from &nancial markets
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Firms: - Rent factors ( L and K ) from factors markets - Receive revenue by selling goods ( Y ) in goods markets Government : - Receive T - Make purchases G - If T > G save ( S g ), If T < G borrow from &nancial markets
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7 Factors of Production K = Capital: - Tools, Machines, Structures used in production L = Labor: - The physical and mental e/orts of workers
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8 Production Function Y = F ( K;L ) - shows how much output ( Y ) can be produced from K units of capital and L units of labor - re&ects the economy±s level of technology - the U.S. shows constant returns to scale technology
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slide_3 - National Income: Where It Comes From and Where It...

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