Chapter 3: National Income Flashcards
How households use income?
Pay taxes
Consume goods and services
Save through the financial markets
How governments use income?
Pay for government purchases
How firms use revenue?
Pay for factors of production
Define public saving
Any excess of tax revenue after government spending. Which can either:
- budget surplus: positive
- budge deficit: negative
What economy output of goods and services (GDP) depends on?
Its quantity of input (factors of production)
Its ability to turn inputs to outputs (production function)
Define factors of production. Define its 2 important factors
Inputs used to produce goods and services.
The 2 most important factors:
- capital: set of tools that workers use
- labor: time people spend working
Define production function
How much output is produced from given amounts of capital and labor.
Define constant returns to scale
Property of production function where an increase in all factors results in an equal increase in output.
What the factors of production and production function determine?
National income
Economy’s output
Define factor prices.
Define 2 important factor prices.
Amount paid to each unit of the factors of production.
Important are:
- wage
- capital rent
Define competitive firm
Firm that has no effects on market prices. So it is a price taker.
Profit depends on what? How can competitive firm maximize profit?
Profit depends on product price, factor prices, factor quantitites.
A price-taker firm takes product and factor price from the market, and decide the profit maximizing factor quantity.
Define diminishing marginal product
The marginal product of X decreases as the amount of X increases (holding other factors fixed)
Define marginal product of labor
Extra amount of output produced when we increase the labor by 1 unit.
How a competitive firm decides to increase the quantity of factors of production?
It compares extra revenue VS extra costs from hiring additional labor.
As long as revenue > cost it will increase
Define real wage
Payment to labor measured in units of production instead of dollars.
Define marginal product of capital
Amount of extra output firm gets when it increasing the capital by 1 unit.
Define rental price of capital
Rental price measured in units of goods produced instead of dollars.
Define consumption function
Higher level of disposable income leads to higher level of consumption
Define MPC
What it equals?
Marginal product to consume is the amount by which consumption changes when disposable income increases by $1
It equals the slope of consumption function
Define interest rate
What happens when interest rate rises?
Cost of funds used to finance investment
When interest rate rises, its more costly to launch projects, therefore less investment.
What is the difference between nominal & real interest rate?
Real interest rate takes into account inflation
Define fiscal policy
Policy that encompasses the government’s decisions about spending and taxation.
What insures that the sum of consumption, investment, government purchases == amount of output produced?
How?
Interest rate.
Higher interest rate leads to lower demand for goods and services
Lower interest rate leads to higher demand for goods and services
