National Income: How it is earned Flashcards
Chapter 3
What is the focus of Chapter 3 in N. Gregory Mankiw’s Macroeconomics?
The focus is on national income, how it is earned, and how total income is distributed between capital and labor.
Neoclassical Theory
A theory explaining how production is determined and income is distributed between capital and labor, based on perfectly competitive markets.
What are the main factors of production according to the Neoclassical theory
The main factors of production are capital (K) and labor (L).
Production Function
A mathematical representation showing how much output (Y) the economy can produce from given quantities of capital (K) and labor (L), expressed as Y = F(K, L).
What does “returns to scale” refer to in production theory?
Returns to scale measure how production output changes when all inputs are scaled by the same factor.
Explain the theory of Increasing Returns to Scale
A situation where output increases by a greater proportion than the increase in inputs, i.e., Y₂ > zY₁ when inputs are doubled.
What does Y2>zY1Y2>zY1 mean?
Y1: Original output
Y2: New output
z: Factor increase in all inputs
If you increase all inputs by z, and output increases by more than z, this is increasing returns to scale.
📊 Example: Double inputs → output becomes more than double.
Explain the theory of constant return to scale
Where output has increased by the same proportion as the increase if the facots of production Y2=ZY1
What does Y2=zY1Y2=zY1 mean?
Y1: Original output
Y2: New output
Z: Factor by which inputs (capital & labor) are increased
If all inputs are multiplied by z, and output also increases by exactly z, then the production function has constant returns to scale.
📊 Example: Double inputs → output doubles.
Explain the theory of decreasing returns to scale
Where the output increases by less than the proportion of the factors of production Y2<ZY1
What does Y2<zY1Y2<zY1 mean?
Y1: Original output
Y2: New output
z: How much inputs increase
If all inputs are increased by a factor of z, but output increases by less than z, this shows decreasing returns to scale.
📊 Example: Double inputs → output increases but by less than double.
What is the Marginal Product of Labor (MPL)?
MPL is the additional output produced by employing one more unit of labor while keeping other inputs constant.
Diminishing Marginal Product
The principle that as one input is increased (while holding others constant), the additional output generated from that input eventually decreases.
How is the equilibrium real wage determined in a labor market?
The real wage is determined by the point where the real wage equals the marginal product of labor
W/P = MPL
Is the labor supply in the neoclassical model elastic or inelastic?
Inelastic - meaning workers are willing to supply a fixed amount of labor regardless of the wage.
Explain how the labor demand is used in the neoclassical model?
Labor demand comes from firms and is based on the marginal product of labor (MPL) — firms hire workers up to the point where the real wage equals MPL:
Real Wage
The wage adjusted for inflation, representing the purchasing power of income earned from labor (W/P).
What conditions must be met for a firm to maximize profit regarding labor?
A firm maximizes profit by hiring labor until the marginal product of labor equals the real wage (MPL = W/P).
The Cobb-Douglas Production Function
Y = AK^α L^(1-α), where A is technology, K is capital, and L is labor
Why does labor earn less than capital in the Cobb–Douglas production function?
In the Cobb–Douglas function
Y=AK^α L^1−α
The income share of each factor depends on the exponent:
Labor earns (1−α)⋅Y(1−α)⋅Y Capital earns α⋅Yα⋅Y
✅ If α= 0.6, 0.6> (1-0.6) then capital earns more than labour.
This reflects an economy where capital is more productive or more heavily used than labor. It can also happen if capital is more scarce or if the economy is more capital-intensive
What trend regarding labor’s share of national income has been observed from 1960 to 2019?
Labor’s share of total income has been gradually declining, from 73% in 1970 to 63% in 2012.
Gini Coefficient
A statistical measure of income inequality ranging from 0 (perfect equality) to 1 (perfect inequality), used to assess income distribution.
What effect has skill-biased technological change had on income inequality?
It has increased the demand and wages for skilled workers while decreasing job opportunities and wages for unskilled workers.
Has the increase in technology increased or decreased the %of skilled workers?
It has decreased the amount of skilled workers and increased the amount of unskilled workers. This is because labor can not keep up with the changes in technology as reduction takes a long time and unfeasible in most scenarios.
