chapter 3 Flashcards
what are the 4 questions models answer?
how much output does the economy produce (value of GDP)
how is the income from production distributed
who buys the output
what brings supply and demand into balance
what is a closed economy?
when there is no international trade for finance
what are the 2 categories of people who get the income in an economy?
capital/ capitalists (makes money on what they own)
labourer (makes money on the labour they can provide)
who are the 3 actors in the economy?
households
governments
firms
what are the 3 ways households interact with the economy?
own factors of production (all businesses are owned by people/ households)
receive income from production
use income to pay taxes, pay for consumption and save
what are the 3 things households using income for?
pay taxes
pay for consumption
save
what does “Y” denote?
income
what does “T” denote?
taxes
what does “C” denote?
consumption
what does “S” denote?
saving
for households, what does income (Y) equal?
income(Y)= consumption(C)+save(S)+taxes(T)
how does the government interact with the economy?
collecting taxes and borrowing
what are the 2 reasons why the government collect taxes and borrows?
to purchase goods and services
transfer income between households
what does “G” denote?
government spending
what are 2 examples of transfers from the government?
welfare and old age security
are government transfers part of government spending on goods and services (G)?
no it is not, because it is moving money around within the economy and not purchasing things with that money
how do firms interact with the economy?
they borrow and use revenues/ receipts from sales
what are the 2 reasons why firms borrow and use revenues/ receipts from sales?
to hire factors of production
to invest in new capital and inventories
what does “I” denote?
investments
can services be inventoried?
no
what is the equation for national income from an income perspective?
Y=C+S+T
what is the equation for national income from an expenditure perspective?
Y=C+I+G
what is the total production of goods and services determined by?
by the available technology and supply of factors of production
what are the 2 factors of production?
labour (L)
capital (K)
what does Y=F(K,L) mean?
output depends on the production function of the 2 components
as input increase, how will that impact output?
it will cause it to increase
what are the 3 things that can cause production to increase?
labour (L)
capital (K)
technology
if labour and capital are held constant, can output increase with the inputs held constant?
yes in technology increases
what is constant returns to scale?
the idea that if there is an N% increase In input there will be the same increase in output, the more capital per worker the more output per worker
if we know what our capital is and what our labour is, what can we figure out?
what our expected output is
how is the distribution of national income determined?
depends on factor prices, which are determined by supply and demand
how is wage rate determined?
through the labour market
how is the rental price of capital determined?
in the capital markets
in both the labor market and the capital market, what is fixed?
the supply of labour and the supply of capital is both fixed by assumption
are competitive firms price takers?
yes
what is the profit function of a firm?
profit= revenue (PY) - cost of labour (WL)- rental price of capital (RK)
what does “W’ denote?
the nominal wage
what does “R” denote?
the rental price of capital
how does a firm maximize profits?
they take the price, nominal wages and rental price of capital as given and they use capital and labor to maximize profits
what is the marginal product of labour (MPL)?
the extra amount of output from hiring one more unit of labour while holding the amount of capital constant
what is diminishing marginal product of labour (MPL)?
when extra output for hiring one more unit of labour decreases as more labour is hired (law of diminishing returns)
refer to the graph of the MPL
if price X marginal product of labour is greater than the wage, how will that impact profits?
profits will increase when one more unit of labour is hired
if price X marginal product of labour is less than the wage, how will that impact profits when one more unit of labbour is hired?
profits will decrease when one more unit of labour is hired
how does a firm maximize profit by using marginal product of labour?
they hire until the last worker hired is creating output that just covers their wage
what does (W/P) denote?
real wage
what is real wage?
a persons wage in terms of the goods and services they can buy
how are the prices of the factor of production determined?
supply and demand
what is the assumption with the labour market and capital market?
supply in both markets are fixed (straight up and down)
what are the 2 ways people generate income?
sale of their labour/ time
rental of capital (owning an appt and renting units)
when would a firm hire workers until?
the marginal output is equal to their wage
what do firms do when wage is high?
hire more due to the higher marginal product of labour
what do firms do when wage is low?
hire less due to lower MPL
what is the equation for marginal product of capital?
MPK= F (K+1,L) - F (K,L)
when do firms buy capital till?
until the marginal product of capital is equal to the rental price of capital
what is the equation for real profit?
Y- W/PL - R/PK
under the idea of constant returns to scale production (Neoclassical theory), are there any economic profits?
no, it is all put in to labour and capital to maximize output
what is the neoclassical theory of income distribution?
the idea that all marginal profit is used to purchase more labor and capital until there is no money left
what are the 4 components of GDP?
consumption (C)
investment (I)
government purchases (G)
net exports (NX) only in an open economy
Y=C+I+G
who is income (Y) paid out to?
households
what do households pay on their income?
taxs
what is disposable income?
income (Y) minus tax (T)
what is consumption an increasing function of?
consumption is an increasing function of disposable income C=C(Y-T)
what can cause someone to not use all of their disposable income on consumption?
expectations of the economy and interest rate
what is marginal propensity to consume (MPC)?
the increase in consumption resulting from a one dollar increase in disposable income
what is an example of marginal propensity to consume (MPC)?
if there is an MPC of .75 that means that a one dollar increase in disposable income results in a 75 cent increase in consumption and the remaining 25 cents are saved
what does the profitability of an investment depend on?
depends on the cost of borrowing
what is the real interest rate?
the interest rate after adjusting for inflation
what does the real interest rate measure?
the real cost of borrowing
what happens to the profitability of investment as the real interest rate increases?
some investments stop being profitable
what is investment a decreasing function of?
real interest rate
when real interest rate goes up, how does that impact investment?
as interest rate goes up investment goes down
what are 2 other things besides real interest rate that impact investment?
political uncertainty
future expectations
what is the equation for the supply of goods and services?
Y bar= F(constant labor and capital)
what is the equation for the demand for goods and services?
Y= C(Y-T) + I(r)+ G bar
in equilibrium supply equal demand, what causes the equation to change?
everything is constant besides investment so investment is what causes change
as the capital per worker increases, what will that impact?
it will make the marginal product per worker increase
what is the Cobb-douglas production function?
the idea that all income gets split between paying for labor and investing in capital
if there is a large wave of immigration how will that impact the labor and capital market?
labor market: it will increase the supply of labor and causes the real wage (W/P) to decrease
capital market: it will cause the demand for capital to increase to meet the increase of workers so they can produce more and increase the marginal product per capital, this increases the rental price of capital (R/P)
how is capital measured?
through the dollar amount of all of the capital
how is housing included in GDP?
if you own a property the expected rent you would pay if you were renting monthly is added in to GDP
what is consumption?
the purchases of goods and services by households
what is the opportunity cost when you dont invest?
the interest real rate, by consuming and not saving you are missing out on gaining the interest rate
what is the formula for national savings?
S= (Y-C-T) + (T-G)
what is the formula for private savings?
Y-C-T
what is the formula for public savings?
T-G
what is national savings?
the amount of income left over after paying for consumption and government spendings
what is the supply of loanable funds?
national savings (S)
what is the demand for loanable funds?
investment (Ir)
how does an increase in government spending impact the market for loanable funds?
if only government spendings has increase and taxes have not, then national savings (supply of loanable funds) will decrease, investment will decrease by the same amount that government spending increases
if there is a decrease in national savings (S), how will that impact the market for loanable funds?
investment will also decrease and the real interest rate will increase
what is an exogenous variable?
it is given and you are not solving for it
what is an endogenous variable?
what you are solving for
what is the formula for investment (I(r))?
ȳ-C (ȳ-t) - G= I(r)
what is the equation for national savings?
S= (Y-C-T) + (T-G)
what happens to to income (Y), interest rate (r), investment (I), consumption (C). if there is an increase in government (G) spending and an equal increase in taxes (T)?
interest rate (R) increases , due to change in equilibrium
investment (I) decreases, due to less supply of funds
consumption (C) decreases, due to higher taxes, MPC also decreases
taxes (T) increase
government spending (G)
income (Y) unchanged, the increase in government spending is balanced out by the decrease In investment and consumption
how would the market for loanable funds change if consumption was a function of (Y-T,r)?
that the supply of loanable funds will not be vertical it will be upwards sloping
how does an increase in government spending without a change in taxes impact the market for loanable funds?
causes the supply of loanable funds to shift to the left, crowding out investment by the same amount as the increase in government spending, Y is unchanged because the increase in government spending is offset by the equal decrease in investment
does a fully funded increase in government spending (G) have an effect on public savings?
no, the increase in taxes offsets the increase in government spending
how does a change in government spending with a change in taxes impact private savings?
causes private savings to decrease by (1-MPC) * change in T
what is the real wage (W/P)?
the units of output that someone can get in terms of the units of labour they work
