School

University of ReginaDepartment

EconomicsCourse Code

ECON202Professor

Maryann VaughanStudy Guide

FinalThis

**preview**shows pages 1-3. to view the full**14 pages of the document.**National Income: Where it Comes From and Where it Goes

Outline of Model

A closed economy, market-clearing model

Supply side

o factor markets (supply, demand, price)

o determination of output/income

Demand side

o determinants of C, I, and G

Equilibrium

o goods market

o loanable funds market

Factors of Production

K = capital: tools, machines, and structures used in production

L = labor: the physical and mental efforts of workers

The Production Function: Y = F(K,L)

shows how much output (Y ) the economy can produce from K units of capital and L

units of labor

reflects the economy’s level of technology, assume some level of technology

exhibits constant returns to scale

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

Returns to Scale: A Review

Initially Y1 = F (K1 , L1 )

Scale all inputs by the same factor z: K2 = zK1 and L2 = zL1

(e.g., if z = 1.2, then all inputs are increased by 20%)

What happens to output, Y2 = F (K2, L2 )?

If constant returns to scale, Y2 = zY1

If increasing returns to scale, Y2 > zY1

If decreasing returns to scale, Y2 < zY1

Constant Returns to Scale

Meaning: If you change all inputs by any positive constant, then output will change by

the same constant.

Let z>0, then zY= F(zK,zL)

Assumptions

1. Technology is fixed.

2. The economy’s supplies of capital and labor are fixed at

Determining GDP

Output is determined by the fixed factor supplies and the fixed state of technology:

Fixed inputs = Fixed outputs

The Distribution of National Income

determined by factor prices, the prices per unit firms pay for the factors of production

o wage = price of L

o rental rate = price of K

Notation

W = nominal wage

R = nominal rental rate

P = price of output

W /P = real wage (measured in units of output)

R /P = real rental rate

and K K L L

,()Y F K L

Only pages 1-3 are available for preview. Some parts have been intentionally blurred.

How Factor Prices are Determined

Factor prices are determined by supply and demand in factor markets.

Recall: Supply of each factor is fixed.

What about demand?

How a Factor of Production is Compensated

Price depends on supply and demand

Assume supply is fixed – implies a vertical supply curve with respect to price

The demand curve is downward sloping

Assume factor markets clear

Demand for Labour

Assume markets are competitive - each firm takes W, R, and P as given.

Firms are price-takers, do not set price level either

Basic idea: A firm hires each unit of labor if the cost does not exceed the benefit. (called a

decision rule)

o cost = real wage

o benefit = marginal product of labor

The competitive firm will hire labour and rent capital in quantities that maximize profits

Marginal Product of Labour (MPL)

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)

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