Economics - Chapter 3

Front 1

Labor (L) and capital (K) are considered the _____ of ______.

Back 1

Factors of Production

Front 2

What is the production function?

Back 2

Y = F(K,L)

Front 3

What is assumed about labor and capital and, thus, output?

Back 3

Labor and capital are fixed and thus, output is fixed.

Front 4

Constant returns to scale indicate what?

Back 4

That for every percentage increase in input, there is an equitable increase in output. For example, adding 10% more labor increases output 10%.

Front 5

______ ________ are the amounts paid to the factors of production.

Back 5

Factor prices.

Front 6

Factor prices in an economy where the two factors of production are _____ & ______

Back 6

Wages; Rent

Front 7

Marginal Product of Labor (MPL) is what?

Back 7

The extra amount of output the firm gets from one extra unit of labor if everything else remains fixed.

Front 8

What is the MPL equation?

Back 8

MPL = F(K, L+1) - F(K,L)

Front 9

Why do most production functions have the property of diminishing marginal product?

Back 9

Adding additional resources does not increase productivity.

Front 10

Real wage is the payment of labor measured in units of what?

Back 10

Output rather than dollars.

In the farmer and barber example, the farmer's real wage is measured in farm goods while the barber's real wage is measured in haircuts.

Front 11

For any given real wage, at which point does the firm stop hiring people?

Back 11

At the point where MPL = real wage. After that, the MPL creates diminishing returns.

Front 12

When does a firm stop demanding factors of production?

Back 12

When the factor's marginal product is equal to its real price.

Front 13

The national accounting identity says that what four things make up GPD?

Back 13

Consumption (C), Business Investment (I), Government Purchases (G), and Net Exports (NX).

Front 14

The income of the household after all taxes are paid.

Back 14

Disposable Income

Front 15

Consumption Function is written as:

Back 15

C(Y-T)

Front 16

What is the marginal propensity to consume?

Back 16

The amount by which consumption changes when disposable income increases by one dollar.

Front 17

How does the investment function relate interest rate (r) and investment (I)?

Back 17

Investment depends on the real interest rate because the interest rate is the cost of borrowing.

The investment function slopes downward: when the interest rate rises, fewer investment projects are profitable.

Front 18

What is the difference between the nominal interest rate and the real interest rate?

Back 18

The nominal interest rate is quoted rate an investor invests at.

The real interest rate is the nominal interest rate adjusted for inflation.

Front 19

True or False: government spending and taxes are, unless otherwise stated, taken exogenously.

Back 19

True!

Front 20

Savings (S) is expressed as:

Back 20

Y - C - G

Front 21

Savings (S) is also called

Back 21

National Savings

Front 22

National Savings is made up of two parts:

1)
2)

Back 22

1) Private Savings
2) Public Savings

Front 23

Private Savings is expressed as:

Back 23

Y - T - C

(disposable income - consumption)

Front 24

Public Savings is expressed as:

Back 24

T - G

(government revenue - government spending)

Front 25

When G > T, a _____ exists.

Back 25

Deficit

Front 26

For FIXED VALUES of Y, G, and T, what is also fixed?

Back 26

Savings (S)

Front 27

In the equation S = I(r), the right hand of the equation shows what?

Back 27

Investment is dependent on the interest rate.

Front 28

1. Why is the labor line vertical?
2. What is this?
3. What adjusts to equate labor supply with labor demand?

Back 28

1. The labor line is vertical because we assume that the supply of labor is fixed.

2. Equilibrium Wage Rate

4. Real Wage

Front 29

Why does investment depend negatively on the interest rate?

Back 29

As the interest rate increases, fewer projects are profitable.

Front 30

True or False: fiscal policy affects savings, investment, and the interest rate.

Back 30

True!

Front 31

Why must investment be affected if government purchases (G) increases?

Back 31

Investment (I) must change because:

1. Total output (Y) is fixed by the factors of production.
2. Taxes have remained the same, so Y-T is constant. Consumption (C) is constant.

Front 32

If (G) increases, how does it affect the interest rate?

Back 32

The interest rate increases, "crowding out" investment.

Front 33

Answer 1. and 2. about how increasing government spending affects savings and investment.

Back 33

1. (S) shifts because increasing (G) did not come with a decrease in (T). Thus, public savings has been reduced. Decreasing public savings decreases national savings, (S).

2. The interest rate (r) rises to create equilibrium.

Front 34

Answer 1. and 2. about how increasing government spending affects savings and investment.

Back 34

1. (S) shifts because increasing (G) did not come with a decrease in (T). Thus, public savings has been reduced. Decreasing public savings decreases national savings, (S).

2. The interest rate (r) rises to create equilibrium.

Front 35

Would the graph for a decrease in taxes (T) be similar to the graph for an increase in government spending (G)?

Back 35

Yes because a decrease in (T), everything else constant, increases disposable income and reduces public saving. When public saving decreases, it decreases national savings.

Front 36

Which two fiscal policy maneouvers "crowd out" investment?

Back 36

Anything that reduces savings - increasing government purchases or decreasing taxes.

Front 37

What is the third fiscal policy action that affects investment, interest rates, and savings?

Back 37

Changes in investment demand.

Front 38

What are two possible causes for changes in investment demand?

Back 38

Technological Innovation
Government encourages/discourages investment through tax laws.

Front 39

If savings (S) is assumed to be fixed, when investment demand changes, how is the interest rate affected?

Back 39

It is raised.

Front 40

If savings (S) is based on interest rate (r), an __________ in investment demand _________ the equilibrium interest rate (r) and _______ the equilibrium (S) and (I).

Back 40

raise, raise, raise

or

decrease, decrease, decrease

When savings is postively related to interest rate, there is a direct relationship between savings, interest rate, and investment demand.

Front 41

What determines the amount of output an economy produces?

Back 41

The factors of production: labor and capital.

Front 42

Explain how a competitive, profit-maximizing firm decides how much of each factor of production to demand.

Back 42

A competitive, profit-maximizing firm decides how much of each factory of production to demand by assessing the diminishing marginal product of each factor.

The firm will stop demanding that particular factor when the real price of the factor equals its marginal product.

Front 43

What determines consumption and investment?

Back 43

Consumption is determined by the consumption function C(Y-T). People consume after they have paid taxes (and sometimes before, haha).

Investment is determined by the interest rate and is described by the function I(r).

Front 44

Explain the difference between government purchases and transfer payments. Give two examples of each.

Back 44

Government purchases are actually the government participating in the economy as an entity, such as purchasing aircraft from Boeing or contracting engineering services from URS.

Transfer payments are a function of the government like social security and welfare. They transfer benefits to people without getting anything in return.

Front 45

What makes the demand for the economy's output of good equal to the supply?

Back 45

Interest rates.

Front 46

Explain what happens to consumption, investment, and the interest rate when the government increases taxes.

Back 46

When taxes are raised, the exact opposite of crowding out happens.

1. Consumption falls.
2. Investment increases
3. Interest rates decrease.