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National Income: Where It Comes From and Where It Goes: Acroeconomics
National Income: Where It Comes From and Where It Goes: Acroeconomics
C H A P T E
R
National Income:
Where it Comes From
and Where it Goes
K = capital:
tools, machines, and structures used in
production
L = labor:
the physical and mental efforts of
workers
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
F (K , L) = KL
F (zK , zL) = (zK )(zL)
= z 2KL
= z 2 KL
= z KL
constant returns to
= z F (K , L)
scale for any z > 0
CHAPTER 3 National Income slide 7
Example 2
F (K , L) = K+ L
F (zK , zL) = zK + zL
= z K+ z L
= z ( K+ L )
decreasing
= z F (K , L) returns to scale
for any z > 1
F (K , L) = K 2 + L2
= z 2 ( K 2 + L2 )
2 increasing returns
= z F (K , L)
to scale for any
z>1
F (K , L) = K + L
F (zK , zL) = zK + zL
= z (K + L)
= z F (K , L) constant returns to
scale for any z > 0
K =K and L=L
Y = F (K , L)
WW ==nominal
nominalwage
wage
RR ==nominal
nominalrental
rentalrate
rate
PP ==price
priceofofoutput
output
W
W/P/P ==real
realwage
wage
(measured
(measuredininunits
unitsofofoutput)
output)
RR/P
/P ==real
realrental
rentalrate
rate
definition:
The extra output the firm can produce
using an additional unit of labor
(holding other inputs fixed):
MPL = F (K, L +1) – F (K, L)
10
50
8
40
6
30
20 4
10 2
0 0
0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10
Labor (L) Labor (L)
a) F (K , L) = 2K + 15L
b) F ( K , L) = KL
c) F ( K , L) = 2 K + 15 L
MPL,
Labor
demand
Units of labor, L
Quantity of labor
demanded
equilibrium
real wage MPL,
Labor
demand
L Units of labor, L
equilibrium
R/P MPK,
demand for
capital
K Units of capital, K
0.4 Labor’s
Labor’s share
share ofof income
income
is
is approximately
approximately constant
constant overover time.
time.
0.2 (Hence,
(Hence, capital’s
capital’s share
share is,
is, too.)
too.)
0
1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 32
The Cobb-Douglas Production
Function
The Cobb-Douglas production function has
constant factor shares:
α = capital’s share of total income:
capital income = MPK x K = α Y
labor income = MPL x L = (1 – α )Y
The Cobb-Douglas production function is:
Y = AK α L1−α
where A represents the level of technology.
CHAPTER 3 National Income slide 33
The Cobb-Douglas Production
Function
Each factor’s marginal product is proportional to
its average product:
αY
α −1 1−α
MPK = α AK L =
K
α −α (1 − α )Y
MPL = (1 − α ) AK L =
L
Demand side
Next determinants of C , I , and G
Equilibrium
goods market
loanable funds market
C (Y –T )
Y–T
I (r )
Aggregate demand: C (Y − T ) + I (r ) + G
Aggregate supply: Y = F (K , L )
Equilibrium: Y = C (Y − T ) + I (r ) + G
I (r )
private saving = (Y – T ) – C
public saving = T – G
national saving, S
= private saving + public saving
= (Y –T ) – C + T–G
= Y – C – G
∆S = ∆Y − ∆C − ∆G = ∆Y − 0.8 ( ∆Y − ∆T ) − ∆G
= 0.2 ∆Y + 0.8 ∆T − ∆G
a. ∆S = − 100
b. ∆S = 0.8 × 100 = 80
c. ∆S = 0.2 × 100 = 20
d. ∆Y = MPL × ∆L = 20 × 10 = 200,
∆S = 0.2 × ∆Y = 0.2 × 200 = 40.
CHAPTER 3 National Income slide 50
digression:
Budget surpluses and deficits
If T > G, budget surplus = (T – G )
= public saving.
If T < G, budget deficit = (G – T )
and public saving is negative.
If T = G , “balanced budget,” public saving = 0.
The U.S. government finances its deficit by
issuing Treasury bonds – i.e., borrowing.
0%
-5%
(% of GDP)
-10%
-15%
-20%
-25%
-30%
1940 1950 1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 52
U.S. Federal Government Debt,
1940-2004
Fact:
Fact: InIn the
the early
early 1990s,
1990s,
120%
about
about 18
18 cents
cents ofof every
every tax
tax
dollar
dollar went
went to to pay
pay interest
interest on
on
100%
the
the debt.
debt.
(Today
(Today it’s
it’s about
about 99 cents.)
cents.)
80%
(% of GDP)
60%
40%
20%
0%
1940 1950 1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 53
Loanable funds supply curve
r S = Y − C (Y − T ) − G
National
National saving
saving
does
does not
not
depend
depend on on r,
r,
so
so the
the supply
supply
curve
curve is
is vertical.
vertical.
S, I
Equilibrium real
interest rate
I (r )
Equilibrium level S, I
of investment
↑G ⇒ ↓ S ↓T ⇒ ↑ C ⇒ ↓ S
3.
3. …which
…which reduces
reduces I (r )
the
the level
level of
of I2 I1 S, I
investment.
investment.
CHAPTER 3 National Income slide 60
Are the data consistent with these
results?