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NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)

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Macroeconomics ECO 403
VU
LESSON 08
NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
(Continued...)
Marginal product of labor (MPL)
def:
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)
Diminishing marginal returns
·
As a factor input is increased, its marginal product falls (other things equal).
·
Intuition:
↑L while holding K fixed
⇒ fewer machines per worker
⇒ lower productivity
MPL and the demand for labor
Units of
output
Each firm hires labor up to the
point where MPL = W/P
Real
wage
MPL, Labor
demand
Units of labor, L
Quantity of labor
demanded
Determining the rental rate
We have just seen that MPL = W/P
The same logic shows that MPK = R/P:
·
diminishing returns to capital: MPK ↓ as K ↑
·
MPK curve is the firm's demand curve
for renting capital.
·
Firms maximize profits by choosing K
such that MPK = R/P.
24
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Macroeconomics ECO 403
VU
The Neoclassical Theory of Distribution
·
states that each factor input is paid its marginal product
·
accepted by most economists
How income is distributed:
Total labor income = W/P x L = MPL x L
Total capital income = R/P x K = MPK x K
If production functions has a constant return to scale, then
Y = MPL x L + MPK x K
Outline of model
A closed economy, market-clearing model
Supply side
·  Factor markets (supply, demand, price)
[Done]
·  Determination of output/income
[Done]
Demand side
·  Determinants of C, I, and G
[Next]
Equilibrium
·  Goods market
·  Loanable funds market
Demand for goods & services
Components of aggregate demand:
C = consumer demand for g & s
I = demand for investment goods
G = government demand for g & s
(Closed economy: no NX)
Consumption, C
·
def: disposable income is total income minus total taxes:
Y­T
·
Consumption function: C = C (Y ­ T)
Shows that ↑(Y ­ T) ⇒ ↑C
Consumption, C
·
Def: The marginal propensity to consume is the increase in C caused by a one-unit
increase in disposable income.
25
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Macroeconomics ECO 403
VU
The consumption function
C
C (Y ­T )
The slope of the consumption
MPC
function is the MPC.
1
Y­T
Investment, I
·
The investment function is
I = I (r )
Where r denotes the real interest rate, the nominal interest rate corrected for inflation.
Investment, I
The real interest rate is
·
- the cost of borrowing
- the opportunity cost of using one's own funds to finance investment spending.
So, ↑r ⇒ ↓I
·
The investment function
r
Spending on investment
goods
is a downward-sloping
function of the real
interest rate
I (r
I
26
Table of Contents:
  1. INTRODUCTION:COURSE DESCRIPTION, TEN PRINCIPLES OF ECONOMICS
  2. PRINCIPLE OF MACROECONOMICS:People Face Tradeoffs
  3. IMPORTANCE OF MACROECONOMICS:Interest rates and rental payments
  4. THE DATA OF MACROECONOMICS:Rules for computing GDP
  5. THE DATA OF MACROECONOMICS (Continued…):Components of Expenditures
  6. THE DATA OF MACROECONOMICS (Continued…):How to construct the CPI
  7. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES
  8. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  9. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  10. NATIONAL INCOME: WHERE IT COMES FROM AND WHERE IT GOES (Continued…)
  11. MONEY AND INFLATION:The Quantity Equation, Inflation and interest rates
  12. MONEY AND INFLATION (Continued…):Money demand and the nominal interest rate
  13. MONEY AND INFLATION (Continued…):Costs of expected inflation:
  14. MONEY AND INFLATION (Continued…):The Classical Dichotomy
  15. OPEN ECONOMY:Three experiments, The nominal exchange rate
  16. OPEN ECONOMY (Continued…):The Determinants of the Nominal Exchange Rate
  17. OPEN ECONOMY (Continued…):A first model of the natural rate
  18. ISSUES IN UNEMPLOYMENT:Public Policy and Job Search
  19. ECONOMIC GROWTH:THE SOLOW MODEL, Saving and investment
  20. ECONOMIC GROWTH (Continued…):The Steady State
  21. ECONOMIC GROWTH (Continued…):The Golden Rule Capital Stock
  22. ECONOMIC GROWTH (Continued…):The Golden Rule, Policies to promote growth
  23. ECONOMIC GROWTH (Continued…):Possible problems with industrial policy
  24. AGGREGATE DEMAND AND AGGREGATE SUPPLY:When prices are sticky
  25. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  26. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…):
  27. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  28. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  29. AGGREGATE DEMAND AND AGGREGATE SUPPLY (Continued…)
  30. AGGREGATE DEMAND IN THE OPEN ECONOMY:Lessons about fiscal policy
  31. AGGREGATE DEMAND IN THE OPEN ECONOMY(Continued…):Fixed exchange rates
  32. AGGREGATE DEMAND IN THE OPEN ECONOMY (Continued…):Why income might not rise
  33. AGGREGATE SUPPLY:The sticky-price model
  34. AGGREGATE SUPPLY (Continued…):Deriving the Phillips Curve from SRAS
  35. GOVERNMENT DEBT:Permanent Debt, Floating Debt, Unfunded Debts
  36. GOVERNMENT DEBT (Continued…):Starting with too little capital,
  37. CONSUMPTION:Secular Stagnation and Simon Kuznets
  38. CONSUMPTION (Continued…):Consumer Preferences, Constraints on Borrowings
  39. CONSUMPTION (Continued…):The Life-cycle Consumption Function
  40. INVESTMENT:The Rental Price of Capital, The Cost of Capital
  41. INVESTMENT (Continued…):The Determinants of Investment
  42. INVESTMENT (Continued…):Financing Constraints, Residential Investment
  43. INVESTMENT (Continued…):Inventories and the Real Interest Rate
  44. MONEY:Money Supply, Fractional Reserve Banking,
  45. MONEY (Continued…):Three Instruments of Money Supply, Money Demand