Government purchases are goods and services bought by

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Unformatted text preview: the firm purchases. Hence, GDP is the total value added of all firms in the economy. Some goods and services do not have market prices. If GDP is to include the values of these, we make an estimate called an imputed value. GDP includes the “rent” that homeowners “pay” to themselves. No imputation is made for the t of capital is the amount of extra output the firm gets from an extra unit of capital, holding labour fixed. MPK = F(K+1, L) – F(K, L). Capital is also subject to diminishing marginal product. The competitive firm hires until the change in profit = 0, meaning that P * MPK = R. In other words, until MPK = R/P, which is the real rental price of capital, measured in goods rather than in dollars. The firm demands each factor of production until that factor’s marginal product falls to equal its real factor price. Economic profit is the income that remains after the firms have paid the factors of production. Real Economic Profit = Y – (MPL * L) – (MPK * K). Page 4 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 Rearranged to isolate Y, this means that total income is divided among the return of labour, the return to capital, and economic profit. Euler’s theorem states that if the production function has constant returns to scale, then F(K, L) = (MPK * K) + (MPL * L). In other words, constant returns to scale, profit maximization, and competition together imply that economic profit is zero. Accounting profit = Economic profit + (MPK * K) since firm owners and capital owners are the same people, so they do not have to pay the real rental price of capital. Total output is divided between the payments to capital and the payments to labour, depending on their marginal productivities. The Cobb- Douglas Production Function shows that the total income of workers and the total income of capital owners share the same proportion of total income. It is expressed by: Y = F(K, L) = A Kα L1- α, where α is a constant between zero and one that measure’s capital’s share of income and A is a parameter greater than zero that measures the productivity of the available technology. The marginal products are MPL = (1- α)Y/L and MPK = αY/K. The MPL is proportional to output...
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