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CHAPTER 3

CHAPTER 3. The Measurement and Structure of the National Economy. Productivity. An economy’s productivity determines the living standards. An economy’s productive capacity depends on 2 factors: 1. the quantities of inputs (land, labor, raw materials, energy …)

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CHAPTER 3

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  1. CHAPTER 3 The Measurement and Structure of the National Economy

  2. Productivity An economy’s productivity determines the living standards. An economy’s productive capacity depends on 2 factors: 1. the quantities of inputs (land, labor, raw materials, energy …) 2. the productivity of inputs (the effectiveness of usage) Labor market equilibrium  determines wages and employment. Level of employment + quantities of other inputs (i.e. capital) + level of productivity  determines level of production.

  3. Production Function – Theory Measures the effectiveness with which capital and labor are used. Is a mathematical expression relating the amount of output produced to quantities of capital and labor utilized. Y = A f(K,N) Y = AKαNβ[by theory,α + β = 1] i.e. Y = AK0.3N0.7 Functions of capital (K) and labor (N) Total factor productivity

  4. Production Function – K vs N From Y = AKαNβ and Y = AK0.3N0.7, Given productivity as A = 18.69 and labor as N = 135.1, then Y = AK0.3N0.7 becomes Y = (18.69)(K0.3)(135.10.7) Y = 579.52K0.3 OR given productivity as A = 18.69 and capital as K = 10,115, then Y = AK0.3N0.7 becomes Y = (18.69)(101150.3)(N0.7) Y = 297.23N0.7

  5. Production Function – K Y • Holding other factors constant, and estimating productivity, A = 18.69, and labor, N = 135.1, then Y = 579.52K0.3 represents the relationship between output, Y and quantities of capital, K, used in production. • i.e. (2001) K = $10,115b • Y = $9215b Y = 579.52K0.3 9215 10115 K

  6. Production Function – K • Upward (positive) sloping: • more capital, more output. • 2. Decreasing slope: • more capital, same labor, • less efficiency. • SLOPE = MPK • Marginal product of capital = ∆Y/∆K • Slope @ T is flatter than slope @ S. Y = 579.52K0.3 Y T S K

  7. Production Function – K MPK is the increase in Y with one unit increase in K. SLOPE = MPK = ∆Y/∆K i.e. MPK @ BC = 733/1000 = 0.73 MPK @ CD = 577/1000 = 0.58 Slope @ CD is flatter than slope @ BC. Slope gets flatter, MPK gets smaller. “Diminishing marginal productivity of K” Y = 579.52K0.3 Y 6977 6400 5667 D C B 2000 3000 4000 K

  8. Production Function – N Y Y = 297.23N0.7 • Holding other factors constant, and estimating productivity, A = 18.69, and capital, K = 10,115, then Y = 297.23N0.7represents the relationship between output, Y and quantities of labor, N, used in production. • i.e. (2001) N = $135.1m • Y = $9215b 9215 135.1 N

  9. Production Function – N • Upward (positive) sloping: • more labor, more output. • 2. Decreasing slope: • more labor, same capital, • less efficiency. • SLOPE = MPN • Marginal product of labor = ∆Y/∆N • Slope @ V is flatter than slope @ U. Y = 297.23N0.7 Y V U L

  10. Production Function – N MPK is the increase in Y with one unit increase in N. SLOPE = MPN = ∆Y/∆N i.e. MPN @ EF = 3721/30 = 124.03 MPN @ FG = 2280/45.1 = 50.6 Slope @ FG is flatter than slope @ EF. Slope gets flatter, MPN gets smaller. “Diminishing marginal productivity of N” Y = 297.23N0.7 Y 9215 6935 3214 G F E 30 90 135.1 N

  11. Supply Shock • Changes in an economy’s • production function due to • changes in other factors besides • labor (N) and capital (K) • a.k.a Production Shock • Beneficial (+ive) vs adverse (-ive) • PF1 to PF2: Invention of minicomputers • Positive supply shock = Production ↑. • PF2 to PF1: Cold winter or drought • Negative supply shock = Production ↓. Y PF2 PF1 N

  12. End of Lecture 1 Week 3 The Production Function Marginal Productivity of Capital (MPK) Diminishing Marginal Productivity of Capital Marginal Productivity of Labor (MPL) Diminishing Marginal Productivity of Labor Supply Shock

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