Review of the previous Lecture • The overall level of prices can be measured by either 1. the Consumer Price Index (CPI), the price of a fixed basket of. goods purchased by the typical consumer 2. the GDP deflator, the ratio of nominal to real GDP .• The unemployment rate is the fraction of the labor force that is not. employed .• When unemployment rises, the growth rate of real GDP falls . Lecture 4 . National Income:.Where it Comes From and Where it Goes - I . Instructor: Prof. Abbas Lecture Contents •. What determines the economy’s total output/income .•. How the prices of the factors of production are determined .•. How total income is distributed .•. What determines the demand for goods and services .•. How equilibrium in the goods market is achieved Outline of model A closed economy, market-clearing side.• factor markets (supply, demand, price).• determination of output/income .Demand side.• determinants of C, I, and G .Equilibrium.• goods market Factors of production K = capital, tools, machines, and structures used in. production .L = labor, the physical and mental efforts of workers The production function •. 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 . Returns to scale Initially Y1 = F (K1 , L1 ) Scale all inputs by the same factor z: K2 = zK1 and L2 = zL1 (If z = , then all inputs are increased by 25%) .What happens to output, Y2 = F (K2 , L2 ) ? • If constant returns to scale, Y2 = zY1 • If increasing returns to scale, Y2 > zY1 • If decreasing returns to scale, Y2 |
