macroeconomics chapter 3 national income: where it comes from and where it goes
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MACROECONOMICSMACROECONOMICS
Chapter 3Chapter 3
National Income: Where National Income: Where It Comes From and It Comes From and
Where It GoesWhere It Goes
22
Sources and Uses of GDPSources and Uses of GDP
How much GDP is produced by the firms How much GDP is produced by the firms in an economy?in an economy?
How the income is divided between labor How the income is divided between labor and capital owners?and capital owners?
Who buys the output of the economy?Who buys the output of the economy?How does the demand for goods and How does the demand for goods and
services match the supply of goods and services match the supply of goods and services?services?
33
How Much GDP?How Much GDP?
Think of the whole economy as a Think of the whole economy as a production function: Y=F(K,L)production function: Y=F(K,L)
In the LONG RUN, markets clear.In the LONG RUN, markets clear.No unemployment in the factor markets.No unemployment in the factor markets.The amount of K and L are thus determined.The amount of K and L are thus determined.
The total amount of Y (GDP=Income) is thus determined.
44
Who Gets What?Who Gets What?
In perfectly competitive factor markets, the In perfectly competitive factor markets, the demand for an input is its marginal demand for an input is its marginal product. product. MPL = MPL = ΔΔY/Y/ΔLMPK = ΔY/ΔK
The supply of a factor was determined to The supply of a factor was determined to be K-bar and L-bar.be K-bar and L-bar.
55
Factor SharesFactor Shares
Q of KQ of L
KL
WR
The demand for capital is the value of the marginal product of capital: P(MPK)The demand for labor is the value of the marginal product of labor: P(MPL)
Explain equilibrium.
At equilibrium R = P(MPK) and W = P(MPL)
WL is labor’s share in $; RK is capital’s share in $
(MPK)P(MPL)P
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Shares of FactorsShares of Factors
If all the firms are operating in perfectly If all the firms are operating in perfectly competitive markets, then P=AC=MC and competitive markets, then P=AC=MC and economic profits (PQ-WL-RK) is zero.economic profits (PQ-WL-RK) is zero.PQ = WL + RKPQ = WL + RKQ = (W/P)L + (R/P)KQ = (W/P)L + (R/P)KY = (MPL)L + (MPK)KY = (MPL)L + (MPK)K
Senator Paul Douglas noticed that (1920s) Senator Paul Douglas noticed that (1920s) the share of labor in the national income the share of labor in the national income remained constant through the years.remained constant through the years.
77
Shares of FactorsShares of Factors
What kind of a production function would What kind of a production function would pay each factor their marginal products pay each factor their marginal products and the marginal products would remain a and the marginal products would remain a constant share of the total income?constant share of the total income?MPL = MPL = αα(Y/L)(Y/L)MPK = (1-MPK = (1-αα)(Y/K))(Y/K)
Cobb-Douglas production function.Cobb-Douglas production function.
88
Cobb-Douglas Production FunctionCobb-Douglas Production Function
It turns out that a function in the following form It turns out that a function in the following form fulfils the required condition.fulfils the required condition.
11 LAKLY
KK LL KK
1KALY
LLAK
LY
1
LY
LY
11)1( KALKY
KKAL
KY
1)1(
KY
KY )1(
99
Properties of Cobb-DouglasProperties of Cobb-Douglas Constant returns to scale: zY=F(zL,zK)Constant returns to scale: zY=F(zL,zK) Declining marginal products: negative 2Declining marginal products: negative 2ndnd
derivativederivative
L L L
K Y Y
a 2a
b
2b
Y
2Y
Y=F(L,K)
MPL
1010
Who Buys the GDP?Who Buys the GDP?NXGICY
)( TYCC )(rII _
GG
For simplicity, let’s assume that NX=0If labor and capital are fixed, Y is fixed.So, the only variable that determines how demand will match supply is r.
HHSTCY
GTS GOV
GOVHH SSI
GCYS
TCYGTS
SSS HHGOV
But from Y = C + I + GI = Y – C – G
1111
Circular FlowCircular Flow
Identify the arrows. Domestic production (GDP) = Expenditures
Income = Expenditures Savings = InvestmentAll equalities imply market clearing.
1212
Another View of EquilibriumAnother View of EquilibriumExpenditures
Y
C=c(Y-T)
C+I+G
Y-bar
1313
Equilibrium in the Financial MarketsEquilibrium in the Financial Markets
rS
I
GOVHH SS What happens if government budget has a deficit?
What happens if investment demand rises?
What happens to investment demand during recessions?