Macroeconomics 1: Long-run Macroeconomics Equilibrium

Question 1

Describe the circular flow of economy

Answer 1

• Households supply factors of production to
  firms
• Firms use factors of production to produce
  goods and services
• Households purchase goods and services
  using income generated from selling factors of
  production
• The Government is a demander of goods and
  services funded by taxes on households
• Prices are flexible and hence all markets are in
  equilibrium
• In equilibrium all factors of production are
  employed: Supply determines output
• In equilibrium all goods and services are sold
  (demand equals supply)

Question 2

Describe the representation of supply with the Aggregate
Production Function

Answer 2

• Two factors of production, Labour and Capital. These are owned by
  households
• Aggregate Production Function
  Y (Output) = F(N,K) where F(.,.) is the production function
  N is labour and K is capital.
• We assume positive and diminishing marginal product
  𝜕𝑌/𝜕𝑁 > 0, 𝜕𝑌/𝜕𝐾 > 0 - gradient is positive BUT 𝜕^2𝑌/𝜕𝑁^2 < 0, 𝜕^2𝑌/𝜕𝐾^2 < 0 - at a decreasing rate
• What about other factors of production such as Land, Exhaustible
  Resources, Human Capital, Environment? Yes, analysis is being limited but it must be done to keep things relatively simple. The best thing to do is just to assume that when N and K change, these things change proportionately with it.

Question 3

What’s the difference between ‘log-run’ and ‘short-run’?

Answer 3

Long-run is not a period of time, it’s a period over which markets adjust and reach market equilibrium via price changes. Before this, it’s short-run

Question 4

Describe and explain the graph of Marginal Product of Labour

Answer 4

‘Output, Y’ on y-axis. ‘Labour, L’ on x-axis. Slope with decreasingly positive gradient - ‘F(K^-, L). 3 triangles along different points of the curve. Horizontal line labelled ‘1’ and vertical line labelled ‘MPL’
1. The slope of the production function equals the marginal product of labour
2. As more labour is added, the marginal product of labour declines