Macroeconomics
ECO 403
VU
LESSON
08
NATIONAL
INCOME: WHERE IT COMES FROM AND WHERE IT
GOES
(Continued...)
Marginal
product of labor (MPL)
def:
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)
Diminishing
marginal returns
·
As
a factor input is increased,
its marginal product falls
(other things equal).
·
Intuition:
↑L while
holding K fixed
⇒
fewer
machines per worker
⇒
lower
productivity
MPL
and
the demand for
labor
Units
of
output
Each
firm hires labor up to
the
point
where MPL = W/P
Real
wage
MPL,
Labor
demand
Units
of labor,
L
Quantity
of labor
demanded
Determining
the rental rate
We
have just seen that MPL =
W/P
The
same logic shows that MPK =
R/P:
·
diminishing
returns to capital: MPK ↓
as K
↑
·
MPK
curve is the firm's demand
curve
for
renting capital.
·
Firms
maximize profits by choosing
K
such
that MPK = R/P.
24
Macroeconomics
ECO 403
VU
The
Neoclassical Theory of
Distribution
·
states
that each factor input is
paid its marginal
product
·
accepted
by most economists
How
income is distributed:
Total
labor income = W/P x L = MPL
x L
Total
capital income = R/P x K = MPK x
K
If
production functions has a
constant return to scale,
then
Y
= MPL x L + MPK x K
Outline
of model
A
closed economy, marketclearing
model
Supply
side
·
Factor
markets (supply, demand,
price)
[Done]
·
Determination
of output/income
[Done]
Demand
side
·
Determinants
of C,
I,
and G
[Next]
Equilibrium
·
Goods
market
·
Loanable
funds market
Demand
for goods &
services
Components
of aggregate demand:
C
= consumer demand for g &
s
I
= demand for investment
goods
G
= government demand for g &
s
(Closed
economy: no NX)
Consumption,
C
·
def:
disposable
income is total income minus
total taxes:
YT
·
Consumption
function: C = C (Y T)
Shows
that ↑(Y
T) ⇒
↑C
Consumption,
C
·
Def:
The marginal
propensity to consume is the
increase in C caused by a
oneunit
increase
in disposable income.
25
Macroeconomics
ECO 403
VU
The
consumption function
C
C
(Y T )
The
slope of the
consumption
MPC
function
is the MPC.
1
YT
Investment,
I
·
The
investment function is
I
= I (r )
Where
r denotes the real interest
rate, the nominal interest
rate corrected for
inflation.
Investment,
I
The
real interest rate is
·

the cost of borrowing

the opportunity cost of
using one's own funds to
finance investment
spending.
So,
↑r
⇒ ↓I
·
The
investment function
r
Spending
on investment
goods
is
a downwardsloping
function
of the real
interest
rate
I
(r
I
26