Class Slides for EC 204 Spring 2006

Class Slides for EC 204Spring 2006

To Accompany Chapter 3

The Production Function

Y =F(K,L)Assume Constant Returns to Scale:

zY=F(zK,zL)Full Employment Determines the Supply of Output:

Y_

=F(K_

,L_

)

The Firm’s Demand for Factors

Firms Maximize:

Profits = Revenue - Labor Costs - Capital Costs= PY - WL - RK= PF(K, L) - WL - RK

Factor Demands are determined by:

MPL(K, L) = W/PMPK(K, L) = R/P

The Division of National IncomeReal Economic Profit = Y - (MPL x L) - (MPK x K)

Y = (MPL x L) + (MPK x K) + Real Economic Profit

Euler’s Theorem: Constant Returns to Scale implies:

F(K, L) = (MPK x K) + (MPL x L)

If factors of production are paid their marginal products, thenthese factor payments sum to total output. Thus, CRS, profitmaximization, and competition imply that Economic Profit = 0.

Since owners of firms usually own the capital, their “profit”is the payment to capital, rK.

Demand for Goods and Services

€

Demand : Y = C + I + G

Consumption : C = C(Y − T)

Investment : I = I(r)

Government Purchases : G = G_

Taxes : T = T_

Equilibrium in Goods Market

Supply of Output: Y =F(K, L)

Demand for Output: Y = C(Y -T) +I(r)+G

At full-employment: Y =F(K_, L

_)=Y

_

Thus: Y_

=C(Y_-T

_)+I(r)+G

_

Equilibrium in Financial Markets

Y -C-G =I

Saving = Investment

(Y -C-T) +(T -G)=I

Private Saving+Public Saving=Investment

Y -C(Y -T) -G=I(r)

Y_-C(Y

_- T

_)-G

_=I(r)

S_

=I(r)

Net Saving 1960-2004

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

Percent of GDP

TotalPersonalBusinessFederal GovtState and Local Govt

Gross Saving 1960-2004

-10%

-5%

0%

5%

10%

15%

20%

25%

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

Percent of GDP

HouseholdBusinessFederal GovtState and Local GovtTotal