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Unformatted text preview: per worker and MPK is proportional to output per unit of capital. Labour income has historically been about 67% in Canada, and capital income about 33%. In a closed economy, the national accounts identity is Y = C + I +G. Consumption: the largest portion of GDP. Income after payment of net taxes, Y – T, is disposable income. The higher is disposable income, the higher is consumption. Thus, C = C(Y – T). The relationship between consumption and disposable income is called the consumption function. The marginal propensity to consume is the amount by which consumption changes when disposable income increases by one dollar. It is the slope of the consumption function. Investment: the quantity of investment is determined by the interest rate. For an investment to be profitable, its return must exceed its cost. If the interest rate rises, fewer investment projects are profitable and investment demand falls. The nominal interest rate is the rate of interest that investors pay to borrow money. The real interest rate is the nominal interest rate corrected for the effects of inflation. The relationship between the real interest rate and the quantity of investment is the investment function, I = I(r). Government purchases: transactions representing the purchase of goods and services account for G. Transfer payments are not included in G. Transfer payments are the opposite of taxes, increasing disposable income. Page 5 of 52 Jessica Gahtan Prof: Mokhles Hossain Macroeconomics ECON2000 Fall 2013 Therefore T equals taxes minus transfer payments. If G = T, the government has a balanced budget. Otherwise, it is a budget deficit or surplus. We take G = G¯, and T = T¯,. Combining all of the above equations into the national accounts identity, we get: Y = C(Y T) + I(r) + G Because G and T are fixed by policy, and output Y is fixed by factors of production, we get: Y¯, = C(Y¯,  T¯,) + I(r) + G¯, The interest rate r is the only variable not already determined in the last equation. This is because it must adjust to ensure that demand for goods equals the supply. At the equilibrium interest rate, the demand for goods and services equals the supply. Y – C – G = I is called national saving or simply saving (S). This can be...
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 Fall '10
 Henriques
 Macroeconomics

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