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CHAPTER
National Income:
Where it Comes From
and Where it Goes
N. GREGORY MANKIW
PowerPoint® Slides by Ron Cronovich
© 2007 Worth Publishers, all rights reserved
In this chapter, you will learn…
K = capital:
tools, machines, and structures used in
production
L = labor:
the physical and mental efforts of
workers
denoted Y = F(K, L)
shows how much output (Y ) the economy can
produce from
K units of capital and L units of labor
reflects the economy’s level of technology
exhibits constant returns to scale
F (K , L) KL
F (zK , zL) (zK )(zL)
z 2KL
z 2 KL
z KL
constant returns to
z F (K , L)
scale for any z > 0
F (K , L) K L
F (zK , zL) zK zL
z K z L
z K L
decreasing
z F (K , L) returns to scale
for any z > 1
F (K , L) K 2 L2
z 2 K 2 L2
2 increasing returns
z F (K , L) to scale for any
z>1
F (K , L) K L
F (zK , zL) zK zL
z (K L)
z F (K , L) constant returns to
scale for any z > 0
K K and LL
Y F (K , L)
W = nominal wage
R = nominal rental rate
P = price of output
W /P = real wage
(measured in units of output)
R /P = real rental rate
definition:
The extra output the firm can produce
using an additional unit of labor
(holding other inputs fixed):
MPL = F (K, L +1) – F (K, L)
60
10
50
8
40
6
30
20 4
10 2
0 0
0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10
Labor (L) Labor (L)
a) F (K , L) 2K 15L
b) F (K , L) KL
c) F (K , L) 2 K 15 L
MPL,
Labor
demand
Units of labor, L
Quantity of labor
demanded
equilibrium
real wage MPL,
Labor
demand
L Units of labor, L
equilibrium
R/P MPK,
demand for
capital
K Units of capital, K
Y MPL L MPK K
0
1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 31
The Cobb-Douglas Production
Function
The Cobb-Douglas production function has
constant factor shares:
= capital’s share of total income:
capital income = MPK x K = Y
labor income = MPL x L = (1 – )Y
The Cobb-Douglas production function is:
Y AK L1
where A represents the level of technology.
C (Y –T )
Y–T
I (r )
Aggregate demand: C (Y T ) I (r ) G
Aggregate supply: Y F (K , L )
Equilibrium: Y = C (Y T ) I (r ) G
I (r )
private saving = (Y – T ) – C
public saving = T – G
national saving, S
= private saving + public saving
= (Y –T ) – C + T–G
= Y – C – G
S Y C G Y 0.8(Y T ) G
0.2 Y 0.8 T G
a. S 100
b. S 0.8 100 80
c. S 0.2 100 20
d. Y MPL L 20 10 200,
S 0.2 Y 0.2 200 40.
CHAPTER 3 National Income slide 49
digression:
Budget surpluses and deficits
If T > G, budget surplus = (T – G)
= public saving.
If T < G, budget deficit = (G – T)
and public saving is negative.
If T = G, “balanced budget,” public saving = 0.
The U.S. government finances its deficit by
issuing Treasury bonds – i.e., borrowing.
0%
-5%
(% of GDP)
-10%
-15%
-20%
-25%
-30%
1940 1950 1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 51
U.S. Federal Government Debt,
1940-2004
Fact: In the early 1990s,
120% about 18 cents of every tax
dollar went to pay interest on
100% the debt.
(Today it’s about 9 cents.)
(% of GDP)
80%
60%
40%
20%
0%
1940 1950 1960 1970 1980 1990 2000
CHAPTER 3 National Income slide 52
Loanable funds supply curve
r S Y C (Y T ) G
National saving
does not
depend on r,
so the supply
curve is vertical.
S, I
Equilibrium real
interest rate
I (r )
Equilibrium level S, I
of investment
G S T C S
r2
2. …which causes
the real interest
r1
rate to rise…
3. …which reduces I (r )
the level of I2 I1 S, I
investment.