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CHAPTER THREE
National Income:
Where it Comes From
and Where it Goes
macroeconomics
fifth edition
N. Gregory Mankiw
PowerPoint Slides
by Ron Cronovich
2003 Worth Publishers, all rights reserved
National Income
slide 1
Outline of model
A closed economy, market-clearing model
Supply side
factor markets (supply, demand, price)
determination of output/income
Demand side
determinants of C, I, and G
Equilibrium
goods market
loanable funds market
CHAPTER 3
National Income
slide 2
Factors of production
K = capital,
L = labor,
CHAPTER 3
National Income
slide 3
CHAPTER 3
National Income
slide 4
National Income
slide 5
(a) F (K , L )
KL
K2
(b) F (K , L )
L
(c) F (K , L ) 2K 15L
(d) F (K , L ) 2 K 15 L
(e) F (K , L ) 2 K 2 15 L2
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National Income
slide 6
K K
CHAPTER 3
and
National Income
L L
slide 7
Determining GDP
Output is determined by the fixed
factor supplies and the fixed state
of technology:
Y F (K , L )
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National Income
slide 8
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National Income
slide 9
Notation
W
= nominal wage
= price of output
W /P = real wage
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National Income
slide 10
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National Income
slide 11
Basic idea:
A firm hires each unit of labor
if the cost does not exceed the benefit.
cost = real wage
benefit = marginal product of labor
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National Income
slide 12
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National Income
slide 13
value of L
function
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National Income
L
0
1
2
3
4
5
6
7
8
9
10
Y MPL
0
10
19
27
34
40
45
49
52
54
55
n.a.
?
?
8
?
?
?
?
?
?
?
slide 14
answers:
Marginal Product of Labor
Output (Y)
Production function
60
50
40
30
20
10
12
10
8
6
4
2
0
0
0
9 10
Labor (L)
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National Income
9 10
Labor (L)
slide 15
MPL
MPL
As more labor is
added, MPL
MPL
labor
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National Income
slide 16
Intuition:
L while holding K fixed
fewer machines per worker
lower productivity
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National Income
slide 17
a) F (K , L ) 2K 15L
b) F (K , L )
KL
c) F (K , L ) 2 K 15 L
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National Income
slide 18
Exercise (part 2)
Suppose W/P = 6.
d. If L = 3, should firm hire
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National Income
L
0
1
2
3
4
5
6
7
8
9
10
Y MPL
0
10
19
27
34
40
45
49
52
54
55
n.a.
10
9
8
7
6
5
4
3
2
1
slide 19
Real
wage
MPL, Labor
demand
Units of labor, L
Quantity of labor
demanded
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National Income
slide 20
Labor
supply
equilibrium
real wage
MPL, Labor
demand
Units of labor, L
National Income
slide 21
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National Income
slide 22
Supply of
capital
equilibrium
MPK, demand
for capital
R/P
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National Income
Units of capital, K
slide 23
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National Income
slide 24
MPL L
MPK K
Y MPL L MPK K
national
income
CHAPTER 3
labor
income
National Income
capital
income
slide 25
Outline of model
A closed economy, market-clearing model
Supply side
DONE
factor markets (supply, demand, price)
DONE
determination of output/income
Demand side
Next determinants of C, I, and G
Equilibrium
goods market
loanable funds market
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National Income
slide 26
CHAPTER 3
National Income
slide 27
Consumption, C
def: disposable income is total income
minus total taxes: Y T
Consumption function: C = C (Y T )
Shows that (Y T ) C
def: The marginal propensity to
consume is the increase in C caused by a
one-unit increase in disposable income.
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National Income
slide 28
C ( Y T )
MPC
1
YT
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National Income
slide 29
Investment, I
The investment function is I = I (r ),
where r denotes the real interest rate,
the nominal interest rate corrected for
inflation.
The real interest rate is
the cost of borrowing
the opportunity cost of using ones
own funds
to finance investment spending.
So, r I
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National Income
slide 30
Spending on
investment goods
is a downwardsloping function of
the real interest rate
I (r )
I
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National Income
slide 31
Government spending, G
G includes government spending on
goods and services.
G G
CHAPTER 3
and
National Income
T T
slide 32
C (Y T ) I (r ) G
Y F (K , L )
Y = C (Y T ) I (r ) G
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National Income
slide 33
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National Income
funds
investment
saving
real interest rate
slide 34
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National Income
slide 35
I (r )
I
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National Income
slide 36
National Income
slide 37
Types of saving
private saving = (Y T ) C
public saving
T G
national saving, S
CHAPTER 3
TG
Y C G
National Income
slide 38
(YT ) = Y T , so
C
= MPC (Y T )
= MPC Y MPC T
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National Income
slide 39
EXERCISE:
c. Y = 100
d. L =
CHAPTER 3
10
National Income
slide 40
Answers
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,
National Income
slide 41
digression:
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National Income
slide 42
percent of GDP
5%
0%
-5%
-10%
-15%
1940
CHAPTER 3
1950
1960
1970
National Income
1980
1990
2000
slide 43
120%
percent of GDP
100%
80%
60%
40%
20%
1940
1950
CHAPTER 3
1960
1970
National Income
1980
1990
2000
slide 44
S Y C (Y T ) G
National saving
does not
depend on r,
so the supply
curve is
vertical.
S, I
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National Income
slide 45
S Y C (Y T ) G
Equilibrium real
interest rate
I (r )
Equilibrium level
of investment
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National Income
S, I
slide 46
YCG =I
Add (C +G ) to both sides to get
Eqm in
L.F. market
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National Income
Eqm in goods
market
slide 47
a. definition
b. intuition for slope
c. all the things that can shift the curve
each item in 2c .
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National Income
slide 48
401(k)
IRA
replace income tax with
consumption tax
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National Income
slide 49
CASE STUDY
spending: G > 0
big tax cuts: T < 0
S Y C (Y T ) G
G S
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National Income
T C S
slide 50
2. which causes
the real interest
rate to rise
S1
r2
r1
3. which reduces
the level of
investment.
CHAPTER 3
S2
National Income
I (r )
I2
I1
S, I
slide 51
1970s
1980s
TG
2.2
3.9
19.6
17.4
1.1
6.3
19.9
19.4
National Income
slide 52
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National Income
slide 53
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National Income
slide 54
r2
S
An increase
in desired
investment
r1
But the equilibrium
level of investment
cannot increase
because the
supply of loanable
funds is fixed.
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National Income
I1
I2
S, I
slide 55
Chapter summary
1. Total output is determined by
how much capital and labor the economy has
the level of technology
2. Competitive firms hire each factor until its
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National Income
slide 58
Chapter summary
4. The economys output is used for
consumption
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National Income
slide 59
Chapter summary
6. A decrease in national saving causes the
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National Income
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CHAPTER 3
National Income
slide 61