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CHAPTER
National Income:
Where it Comes From
and Where it Goes
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…
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
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 LL
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:
= capital’s share of total income:
capital income = MPK x K = Y
labor income = MPL x L = (1 – )Y
The Cobb-Douglas production function is:
Y AK L1
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:
1 1 Y
MPK AK L
K
(1 )Y
MPL (1 ) AK L
Consumption function: C = C (Y – T )
Shows that (Y – T ) C
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?