# Macro economics

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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.
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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
Y = MPL x L + MPK x K
Outline of model
A closed economy, market-clearing 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 one-unit
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 downward-sloping
function of the real
interest rate
I (r
I
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