1. Lecture 3
National Income

2. Production function

3. Production function: scale economy
If double the K and the L:
Output is doubled  constant return to scale
Output is less than doubled  decreasing return to scale
Output is more than doubled  increasing return to scale

4. Production function: scale economy
Example: STARBUCKS
In the 1990s  probably increasing return to scale. The company opens a new store every weekday.
Since 2008  probably decreasing return to scale. The company has announced 900 store closure in the US.

5. Demand for capital and labor

6. Demand for capital and labor

7. Discussions #1 MPL = W. If Cobb-Douglas function,
At the given level of K, a higher number of workers would lead to a lower wage.

8. Discussion #1 Wage wage MPL, labor demand Labor Quantity of labor
demanded
Labor

9. Discussions #1 Similarly, MPK = R, we have:
Since α – 1 < 0, at any given level of L, a higher K would lead to a lower interest rate.

10. Supply is vertical in the whole country

11. Two basic predictions of the model
At any given level of L, a higher K would lead to a lower interest rate.
At any given level of K, a higher number of workers would lead to a lower wage.
Verifying these two predictions are very difficult.

12. Example: the Black Death

13. The Black Death
The total number of death world wide are estimated at 75 million.
Approximated million in Europe, about 30% to 60% of Europe’s population.

14. The effect of the Black Death on wages
Labor supply after
Labor supply before
wage after
wage before

15. The Golden Age of British Laborers
Wages did not move much long before the Black death.
Wages have almost doubled after the Black death.
It is still controversial.

16. Example: Mariel Boatlift
Began 4/15/1980, and ended 10/31/1980.
More than 125,000 Cubans arrived at Southern Florida, mostly in Miami.
50% of them stay in Miami – a 7% increase of the Miami labor market and 20% increase in Cuban working population.

17. Example: Mariel Boatlift

18. The Mariel Boatlift

19. The effect of the Mariel Boatlift on wages
Labor supply before
Labor supply after
wage before
wage after

20. The effect of the Mariel Boatlift on wages
Not much change in wages for both Cuban workers and for Caucasian workers.
Why?

21. The effect of the Mariel Boatlift on wages
Labor supply before
Labor supply after
wage before
Demand for labor shift right since capital stock increases
wage after

22. Discussion #2: share of income
output

23. Share of income
Nonwage benefits, such as health insurance etc

24. Demand for goods and services
GDP = Consumption (C) +
Investment (I) +
Government Purchase (G) +
Net Exports (NX)
If NX = 0
Government Purchase (G)

25. Consumption Depends on the disposable income:
C = C(Y – T) = a + b * (Y – T)
Example:
C = (Y – T)
Marginal propensity to consume: 0.75
On additional dollar, only 75 cents are consumed, the rest is saved.

26. Investment function
A higher cost or rental price of capital would lead to a lower investment.
Example of investment function:
I = I(r) = 1,000 – 50 r.

27. Equilibrium of demand and supply
GDP equation:
Y = C + I + G = C(Y-T) + I(r) + G
Rewrite:
Y – C – G = I
Supply of loanable fund:
Y – C – G = Saving
Demand for loanable fund:
I(r)

28. Equilibrium of demand and supply

29. Case 1: an increase in government spending, G.

30. Is this true?

31. Case 2: Bush’s cut in capital gains tax

32. Summary
Total output is determined by the economy’s quantities of capital and labor (and technology).
Y = F(K, L)
Competitive firms hire both K and L until its marginal product equals its price.

33. Summary Profit is maximized when MPK = R and MPL = wage.
A closed economy’s output is used for:
Y = C + I + G
In the long run, the equilibrium is reached when saving and investment are equal.