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Private Saving
Financial Markets
Public Saving
Taxes
Households Government Firms
Government Investment
Purchases
CAPITAL (K)
Is the set of tools that
workers use
LABOR (L)
Is the time people spend
working
ASSUMPTIONS
Assumption 1: the economy has a fixed amount of capital and a
fixed amount of labor
The overbar means
K=K that each variable is
fixed at some level
L=L
Y = F(K, L)
zY = F(zK, zL)
SUPPLY OF GOODS AND SERVICES
Y = F(K, L)
=Y
HOW IS NATIONAL INCOME DISTRIBUTED
TO THE FACTORS OF PRODUCTION
Equilibrium
Factor Price
Factor
demand
Quantity of factor
DECISIONS FACING THE COMPETITIVE FIRM
The competitive firm takes the prices of its output and its inputs as
given by the market condition
In order to produce a product, a firm needs two
factors of production, capital and labor
The firm sells its
output at a price P,
Y = F(K, L) hires workers at a
wage W and rents
capital at a rate R
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The goal of the firm is to maximize profit
It is what the owners of the firm keep after paying for the costsof
production
Profit = PF(K, L) – WL – RK
THE FIRM’S DEMAND FACTOR
P x MPL = W or
MPL = W/P
W/P is the real wage
Maximized Profit:
Firm hires up to the point at which the MPL equals
the real wage
Units of
output
Each firm hires labor
up to the point where
MPL = W/P.
Real
wage
MPL, Labor
demand
Units of labor, L
Quantity of labor
demanded
MARGINAL PRODUCT OF CAPITAL AND
CAPITAL DEMAND
MPK = R/P