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Econ 3.docx

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University of Maryland
ECON 305

Econ chapter 3  National income: where it all comes from and where it goes  GDP depends on  Quantity of output, FOP’s  Ability to turn inputs into output  Factors of production: inputs used to produce goods and services  Capital: set of tools that workers use (K)  Labor: time people spend working (L)  Both are fixed (bar over) and none wasted  Production function: shows how the quantities of FOP’s determine the quantity of goods and services produced.  Y = F (K, L)  Output is a function of the amount of capital and labor  Available technology for turning capital and labor into output  Constant returns to scale: an increase of an equal percentage in all FOP’s causes an increase in output of the same percentage.  zY = F ( zK , zL)  Neoclassical theory of distribution  factor prices: amounts paid to the FOP’s  for labor and capital they are wages and rent  Competitive firm: small relative to the markets in which it trades, so it has little influence on the market prices.  Uses market prices because otherwise they would go out of business from other firms  Maximize profit: = revenue – costs • Revenue = P x Y (p = selling price / y = amount produced) • Labor costs = W x L (wage times amount of labor) • Capital costs = R x K (rental price of capital times amount of capital) ♦ Profit = PY – WL – RK (revenue – labor costs – capital costs)  Profit = PF (K,L) – WL – RK  Marginal product of labor (MPL): extra amount of output the firm gets from one extra unit of labor, holding capital fixed.  MPL= F (K, L+1) – F (K, L)  Diminishing marginal product: holding the amount of capital fixed, the MPL decreases as the amount of labor increases.  Each worker makes less bread because there are more people and only a small kitchen, making it crowded.  Afirm hires works until the extra revenue = wage • Profit = (P x MPL) – W ♦ MPL = W/P  W/P = real wage: the payment to labor measured in units of output rather than dollars.  MPL = labor demand curve  Marginal product of capital (MPK): amount of extra output the firm gets from an extra unit of capital, holding labor constant.  MPK = F(K + 1, L) – F(K,L) • Difference between k and k +1  MPK = R / P  Real rental price of capital: rental price measured in units of goods rather than in dollars.  ***the firm demands each factor of production until that factor’s marginal product falls to equal its real factor price***  Economic profit: the income that remains after the firms have paid the FOP’s  Economic profit = Y – (MPL x L) – (MPK x K)  Accounting profit: the amount of revenue remaining for the owners of a firm after all the FOP’s, except capit
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