Macroeconomics 5: Using the long-run model

Question 1

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Describe the share of national income between the factors of production

Include brief figures of shares of US and UK

Answer 1

• The share of income which goes to labour and capital depends on how the
  marginal product changes as K and N vary
• We can examine the issue of division of income between capital and labour by
  using the Cobb-Douglas production function Y = A NV K(1-V)
• We have MPN =real wage= vY
  N and MPK =real rental price of capital = (1−v)Y
  K
• Share of income going to Labour = (MPN x N)/Y = (vY
  N x N)/Y = v
• Share of income going to Capital = (MPK x K)/Y = ((1-v)Y
  K x K)/Y = (1-v)
• Hence, as long as v is constant over time so is the share of income going to capital
  and labour. In UK v is estimated around 0.75 while in US it is found to be around
  0.7

Question 2

Describe the graph of change in share of labour income over time and list influencing factors

Answer 2

• Y-axis labelled “labour’s share of total income” ranged from 0-1, x-axis labelled “Year” ranged from 1960-2019. Line fluctuates around 0.7 throughout the graph but starts at 0.7 and gradually decreases to 0.68
• Other factors influencing
  income share include:
  Technological change
  Firms/Trade Unions bargaining
  power
  Tax system

Question 3

Describe & explain the role of Government in National Savings and
Real Interest Rate

Answer 3

The long-run trend of National Saving is driven
mainly by household decisions. Short-run
variation is mainly dependent on Government
expenditure/tax decisions
We can use the closed/global economy model to
illustrate historical episodes (when financial
markets were not integrated) and to consider
the impact of Government budget decision-
making
Suppose Governments spend more. National
saving will fall. Interest rates will rise. Historically
this has been an important driver of interest
rates
Description of graph:
Y-axis labelled “Real interest rate, r”, x-axis labelled “Investment, Saving, I, S”. Increasingly negative slope labelled “I(r)”. Vertical slope labelled “S1”. Dotted line going from S1 and I(r)’s interesection to y-axis; at y-axis at that height, there’s “r1”. There’s another vertical line to the left of S1 labelled “S2”. Again, there’s a dotted line going from S2 and I(r)’s interesection to y-axis; at y-axis at that height, there’s “r2”. Leftward arrow between S1 and S2 labelled “1. A fall in saving…”. Upward arrow between r1 and r2 labelled “2. …raises the interest rate…”