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41 Cards in this Set
- Front
- Back
GDP measures what?
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Both total income and total output
income = total output |
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What determines the GDP
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1. Quantity of factors of production
2. Ability to turn inputs (factors of production) into output (production function) |
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Factors of Production
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2 most important factors of production
1. Capital (K) 2. Labor (L) _ K = Fixed amount of Capital _ L = Fixed amount of Labor |
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The Production Function
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Y = F(K,L)
Output depends upon (is a function of) the amount of capital (K) and Labor (L) available to the economy |
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Constant returns to scale
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when an increase of an equal percentage in all factors of production causes an increase in output of the same percentage.
zY = F(zK,zL) where z is any positive number |
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Factors of production & the production function determine what?
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quantity of goods and services supplied = Y
or _ Y = F( Kbar, Lbar ) |
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neo-classical theory of distribution
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the best place to start understanding how the economy's income is distributed from firms to households
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Factor Prices
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determines distribution of national income
the amounts paid to the factors of production. Wages to workers (L) Rent to the owners of capital (K) |
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Profit =
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P=Price
Y=output/units produced W=Wages L=Labor Hours R=Rate (interest) K=Capital Profit = Revenue - Labor Costs - Capital Costs or PxY - WxL - RxK |
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to see HOW profit depends on the factors of production we can substitute the production function in to the profit equation for Y
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PxF(K,L) - WxL -RxK
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A competitive firm will take the product price and the factor prices as given and then chooses what?
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the amount of labor and capital that will maximize profit
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The Marginal Product of Labor (MPL) i
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the extra amount of output the firm gets from one extra unit of labor, holding the amount of capital fixed.
we can see this using the production function MPL = F(K, L +1) - F(K,L) The MPL is a firms labor demand curve |
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Most production functions exhibit the property of Diminishing Marginal Product:
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holding the amount of capital fixed, the marginal product of labor decreases as the amount of labor increases
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The Marginal Product of Labor (MPL) is the slope of what?
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the production function
see pg 52 fig 3.3 |
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the competitive firm will hire when what = what?
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MRPL = W
or PxMPL = W The firms manager knows that if the extra revenue Px MPL exceeds teh wage W and extra unit of labor increases profit. (P x MPL) - W = Profit |
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MPL = W/P
what doe sthis mean? |
W/P is the REAL WAGE--the payment to labor measured in units of output rather than in dollars.
To maximize profit, the firm hires up to the point at which the marginal product of labor equals the real wage. just another way of saying (MRPL = W) = (MPL = W/P) |
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Marginal Product of Capital (MPK)
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the amount of extra output the firm gets from an extra unit of capital, holding labor constant.
MPK = F(K+1, L) - F(K,L) The difference between the amount of output produced with K+1 units of capital and that Produced with only K units of capital |
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Capital is subject to diminshing marginal product?
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true
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the increase in profit from renting an additional machine is the extra revenue from selling the output of that machine minus the machines rental price
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true
Change in Profit = (P x MPK) - R |
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To maximize profit a firm will continue to rent new capital until the MPK....
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falls to equal the rental price
or rent capital until MPK = R/P (the real rental price of capital) |
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The competitive profit maximizing firm hires labor or rents capital
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until the factor's marginal product EQUALS its REAL factor price
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Total real wages paid to labor =
Total real return paid to capital owners is |
MPL x L
MPK x K |
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The income that remains after the firms have paid the factors of production is the ECONOMIC PROFIT
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Real Economic Profit is
Econ. Profit = Y - (MPL x L) - (MPK x K) OR Y = (MPL x L) + (MPK x K) + Econ. Profit |
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Total income is divided among:
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Return to labor (wages)
Return to capital (Rent) Economic Profit (whats left goes to FIRM) |
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Euler's Theorem
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F(K, L) = (MPK x K) + (MPL x L)
constant returns to scale, profit maximization, and competition together imply that economic profit = 0 If each factor of production is paid its marginal product, then the sum of these factor payments equals total output |
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Accounting Profit =
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Economic Profit + (MPK x K)
Because firm owners and capital owners re the same people, economic profit and the return to capital are often lumped together. "profit" must mostly be the return to capital (MPK x K) |
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Total output is divided between the payments to capital and the payments to labor, depending on their marginal productivities
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true
economic profit = 0 becase each factor of production is paid its marginal product and as a result these factor payments exhaust total output |
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Cobb-Douglas Production Function
pg. 57--Walk through proof |
alpha = a constant between 0 and 1. alpha determines what share of the income goes to capital and what share goes to labor
A = Parameter greater than 0 that measures the productivity of the available technology F(K,L) = A x K^alpha x L ^(1-alpha) |
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Properties of the Cobb-Douglas Function
Review pg. 58 now! |
has constant returns to scale (if capital and labor are increased by the same proportion then output increases by the same proportion)
MPL = (1-alpha) x A x K^alpha x L^-alpha MPK = alpha x A x K^alpha-1 x L^1-alpha OR MPL = (1-alpha)Y/L MPK = alphaY/K MPK = |
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Y/L = Average labor productivity
Y/K = Average capital productivity |
true
if the production function is Cobb-Douglas then the marginal productivity of a factor is proprotinal to its average productivity |
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1-alpha is labors share of output
alpha is capital's share of outupt |
true
the ratio of labor income to capital income is the constant (1-alpha)/alpha |
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labor productivity and what are closely related?
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real wages (W/P)
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National Income for a CLOSED economy
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Y = C + I + G
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Disposable income
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Y-T
households divide their disposable income between consumption and savings |
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Consumption is a function of what?
pg. 62 |
Disposable income:
C = C(Y-T) The consumption function The slope of the consumption function is the Marginal Propensity to Consume (MPC) the MPC is between 0 and 1 |
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the quantity of investment goods demanded depends on
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the REAL interest rate
nominal interest rate = real interest rate + inflation I = I(r) |
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If government purchases equal taxes minus transfers then G=T, if G > T then the government runs a budget deficit, which it funds by issuing govt. bonds, if G<T the government runs a budget surplus, which it can use to repay some of its outstanding debt
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true
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Endogenous variables
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Consumption
Investment Interest Rates |
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rvw pg. 66
_ Y = C(Ybar - Tbar) + I(r) +Gbar |
this equation sates that the supply of output equals its demand, which is the sum of consumption, investment, and government purchases
notice that the real interest rate is the only variable not already determined or fixed (bar). it adjusts to ensure that the demand for goods aequals the supply. the greater the interest rate, the lovwer the level of investment, and thus the lower the demand for goods and services (C + I + G) <b>At the equilibrium interest rate the demand for goods and services equals supply</b> |
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Y - C - G = I = S
or Y - C(Y-T) - G = I(r) or _ Y = C(Ybar-Tbar) - Gbar = I(r) Sbar=I(r) pg. 67 |
National saving (S) is the sum of private + public savings
In closed economy: Savings = Investments S=(Y-T-C) + (T-G) = I Y-T-C = Private Savings T-G = Public Savings The flows into the ifinancial markets (private and public savings) must balance the flows out of the financial markets (Investment) |
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At the equilibrium interest rate in the market for loanable funds, households' desire to sae balances firms' desire to invest, and the quantity of loanable funds supplied equals the quantity demanded
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true
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