Rc Chapter03 Summary

8/9/2019 Rc Chapter03 Summary

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CHAPTER "CHAPTER " National Income National Income slide 2

#$tline o% mo!el#$tline o% mo!el

A closed economy, market-clearing modelSupply side

factor markets (supply, demand, price) determination of output/income

Demand side determinants of C , I, and G

Equilibrium goods market loanable funds market


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actors o% &ro!$ctionactors o% &ro!$ction

K = capital,tools, machines, andstructures used in production

L = labor,the physical and mentale orts of !orkers


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The &ro!$ction %$nctionThe &ro!$ction %$nction

denoted Y = F (K , L)sho!s ho! much output ( Y ) theeconomy can produce fromK units of capital and L units of labor"

re#ects the economy$s le%el oftechnology"

e&hibits constant returns to scale "


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Returns to scale: a review Returns to scale: a review

'nitially Y 1 = F (K 1 , L1 )

Scale all inputs by the same factor z :

K 2 = zK 1 and L2 = zL 1

('f z = " *, then all inputs are increased by*+)

hat happens to output, Y 2 = F (K 2 , L2 ) -

'f constant returns to scale , Y 2 = zY 1 'f increasing returns to scale , Y 2 . zY 1

'f decreasing returns to scale , Y 2 zY 1


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Ass$m&tions o% the mo!elAss$m&tions o% the mo!el

" 0echnology is 1&ed"" 0he economy$s supplies of capital

and labor are 1&ed at

and= =K K L L


7/36CHAPTER "CHAPTER " National Income National Income slide 7

'etermining G'P'etermining G'P

2utput is determined by the 1&edfactor supplies and the 1&ed stateof technology3

,= ( )Y F K L



The !istri($tion o% national incomeThe !istri($tion o% national income

determined by factor prices ,the prices per unit that 1rms pay forthe factors of production"

0he wage is the price of L ,the rental rate is the price of K "



NotationNotation

W = nominal !age

R = nominal rental rate

P = price of output W /P = real !age

(measured in units of output)

R /P = real rental rate

W = nominal !age

R = nominal rental rate

P = price of output W /P = real !age

(measured in units of output)

R

/P = real rental rate


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'eman! %or la(or 'eman! %or la(or

4ssume markets are competiti%e3each 1rm takes W , R , and P as gi%en

5asic idea3

4 1rm hires each unit of laborif the cost does not e&ceed the bene1t" cost = real !age

bene1t = marginal product oflabor


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E)ercise:E)ercise: compute & graph MPLcompute & graph MPLa" Determine PL at each

%alue of L

b" 6raph the productionfunction

c" 6raph the PL cur%e !ithPL on the

%ertical a&is andL on the hori7ontal a&is

d" Dim" 8arginal 9roducti%ity

L Y PL: : n"a"

: -; -

< >?


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answers:answers:

Pro!$ction %$nction

0

10

20

30

40

0

!0

0 1 2 3 4 ! " # $ 10

*a(or +*,

# $

t & $

t + - ,

Marginal Pro!$ct o% *a(or

0

2

4

!

#

10

12

0 1 2 3 4 ! " # $ 10

*a(or +*,

M P * + $ n

i t s o

% o $

t & $

t ,


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Y output

The MPL and the productionThe MPL and the productionfunctionfunction

Llabo

r

F K L( , )

MPL

MPL

MPL 4s more labor

is added, MPL

Slope of theproduction functionequals MPL


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Exercise (part 2)Exercise (part 2)

Suppose W / P = @"

d" 'f L =


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'etermining the rental rate'etermining the rental rate

e ha%e Aust seen that PL = W / P 0he same logic sho!s that PK = R / P 3

diminishing returns to capital3 PK as K

0he PK cur%e is the 1rm$s demand cur%efor renting capital"

Birms ma&imi7e pro1ts by choosing K such that PK = R / P "


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'eman! %or goo!s ser/ices'eman! %or goo!s ser/ices

Components of aggregate demand3C = consumer demand for g s

I = demand for in%estment goods

G = go%ernment demand for g s

(closed economy3 no !" )


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Cons$m&tion0Cons$m&tion0 CC

def3 disposable income is totalincome minus total ta&es3 Y #

Consumption function3 C = C (Y # )

Sho!s that

(Y # )

C def3 0he marginal propensity toconsume is the increase in C caused

by a oneFunit increase in disposableincome"


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The cons$m&tion %$nctionThe cons$m&tion %$nction

C

Y $ #

C (Y# )

MPC 0he slope of theconsumptionfunction is the

89C"


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In/estment0In/estment0 II

0he in%estment function is I = I (r ),!here r denotes the real interestrate , the nominal interest ratecorrected for in#ation"

0he real interest rate is the cost of borro!ing the opportunity cost of using

one$s o!n fundsto 1nance in%est ment spending"

So, r I


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The in/estment %$nctionThe in/estment %$nction

r

I

I (r )

Spending onin%estment goodsis a do!n!ardFsloping function ofthe real interestrate


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Go/ernment s&en!ing0Go/ernment s&en!ing0 GGG includes go%ernment spending ongoods and ser%ices"

G e&cludes transfer payments

4ssume go%ernment spending andtotal ta&es are e&ogenous3

= = andG G # #


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The market %or goo!s ser/icesThe market %or goo!s ser/ices

The real interest rate adjuststo e uate demand !ith supply"The real interest rate adjusts

to e uate demand !ith supply"

4gg" demand3 ( ) ( )C Y # I r G + +

4gg" supply3 ( , )Y F K L =

Equilibrium3 = ( ) ( )Y C Y # I r G + +


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The loana(le %$n!s marketThe loana(le %$n!s market

4 simple supplyFdemand model ofthe 1nancial system"

2ne asset3 Gloanable fundsH demand for funds3 in%estment supply of funds3 sa%ing

GpriceH of funds3 real interest

rate


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*oana(le %$n!s !eman! c$r/e*oana(le %$n!s !eman! c$r/e

r

I

I (r )

0he in%estmentcur%e is also thedemand cur%e

for loanablefunds"


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1$&&ly o% %$n!s: 1a/ing1$&&ly o% %$n!s: 1a/ing

0he supply of loanable funds comes fromsa%ing3 Iouseholds use their sa%ing to make

bank deposits, purchase bonds andother assets" 0hese funds becomea%ailable to 1rms to borro! to 1nancein%estment spending"

0he go%ernment may also contribute tosa%ing if it does not spend all of the ta&re%enue it recei%es"


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Ty&es o% sa/ingTy&es o% sa/ing

private saving = ( Y # ) Cpublic saving = # G

national saving , % = pri%ate sa%ing J public sa%ing

= ( Y # ) C J # G

= Y C G


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digression:digression:2$!get s$r&l$ses an! !e%icits2$!get s$r&l$ses an! !e%icits

hen # . G ,budget surplus = ( # G ) = publicsa%ing

hen # G ,budget de cit = ( G # )and public sa%ing is negati%e"

hen # = G ,budget is balanced and public sa%ing = :"


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The 3.1. e!eral Go/ernment 2$!getThe 3.1. e!eral Go/ernment 2$!get

(# FG ) as a + of 6D9

%12

%#

%4

0

4

1$40 1$ 0 1$!0 1$"0 1$#0 1$$0 2000

& o

f ' ( P

(# FG ) as a + of 6D9

%12

%#

%4

0

4

1$40 1$ 0 1$!0 1$"0 1$#0 1$$0 2000

& o

f ' ( P


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The 3.1. e!eral Go/ernment 'e(tThe 3.1. e!eral Go/ernment 'e(t

0

20

40

!0

#0

100

120

1$40 1$ 0 1$!0 1$"0 1$#0 1$$0 2000

P e r c e n

t o f ' ( P

0

20

40

!0

#0

100

120

1$40 1$ 0 1$!0 1$"0 1$#0 1$$0 2000

P e r c e n t o

f ' ( P

Fun fact: In the early 1$$0s)

nearly 1# cents of every ta*dollar went to +ay interest onthe debt,

(Today its about 9 cents.)

Fun fact: In the early 1$$0s)

nearly 1# cents of every ta*dollar went to +ay interest onthe debt,

(Today its about 9 cents.)


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*oana(le %$n!s s$&&ly c$r/e*oana(le %$n!s s$&&ly c$r/e

r

%& I

( )% Y C Y # G=

Kationalsa%ing doesnot dependon r ,so the supplycur%e is%ertical"


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*oana(le %$n!s market e4$ili(ri$m*oana(le %$n!s market e4$ili(ri$m

r

%& II (r )

( )% Y C Y # G=

-./ilibri/m realinterest rate

-./ilibri/m levelof investment


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Mastering the loana(le %$n!s mo!elMastering the loana(le %$n!s mo!el

" 0hings that shift the sa%ing cur%ea" public sa%ingi" 1scal policy3 changes in G or #

b" pri%ate sa%ingi" preferencesii" ta& la!s that a ect sa%ing

?: (k)

'L4 replace income ta& !ithconsumption ta&


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CA1E 1T3'-CA1E 1T3'-

The Reagan 'e%icitsThe Reagan 'e%icits

Leagan policies during early ;>:s3 increases in defensespending3 G . :

big ta& cuts3 # :

4ccording to our model, both policiesreduce national sa%ing3

( )% Y C Y # G=

G % # C %


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5. The Reagan !e%icits5. The Reagan !e%icits 0 cont.0 cont.

r

%& I

%

I (r )

r #

I#

r $2, which ca/ses

the real interestrate to rise

I$

3, which red/cesthe level ofinvestment,

1, he increase inthe deficitred/ces savin

%


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Are the data consistent with these results Are the data consistent with these results

%ariable ; :s ;>:s

# G "


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CHAPTER "CHAPTER " N i l IN i l I

Mastering the loana(le %$n!s mo!elMastering the loana(le %$n!s mo!el

" 0hings that shift the in%estment cur%ea" certain technological inno%ations to take ad%antage of the inno%ation,

1rms must buy ne! in%estment

goodsb" ta& la!s that a ect in%estment

in%estment ta& credit

Rc Chapter03 Summary

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