Macroeconomics
CHAPTER
3
National Income: Where It Comes From and Where It Goes
Questions for Review
1. The factors of production and the production technology determine the amount of output an economy can produce. The factors of production are the inputs used to produce goods and services: the most important factors are capital and labor. The production technology determines how much output can be produced from any given amounts of these inputs. An increase in one of the factors of production or an improvement in technology leads to an increase in the economy’s output.
2. When a firm decides how much of a factor of production to hire or demand, it considers how this decision affects profits. For example, hiring an extra unit of labor increases output and therefore increases revenue; the firm compares this additional revenue to the additional cost from the higher wage bill. The additional revenue the firm receives depends on the marginal product of labor (MPL) and the price of the good produced (P). An additional unit of labor produces MPL units of additional output, which sells for P dollars per unit.
Therefore, the additional revenue to the firm is P × MPL. The cost of hiring the additional unit of labor is the wage W. Thus, this hiring decision has the following effect on profits:
ΔProfit = ΔRevenue – ΔCost
= (P × MPL) – W.
If the additional revenue, P × MPL, exceeds the cost (W) of hiring the additional unit of labor, then profit increases. The firm will hire labor until it is no longer profitable to do so—that is, until the MPL falls to the point where the change in profit is zero. In the equation above, the firm hires labor until Δprofit = 0, which is when (P × MPL) = W.
This condition can be rewritten as:
MPL = W/P.
Therefore, a competitive profit-maximizing firm hires labor until the marginal product of labor equals the real wage. The same logic applies to the firm’s decision regarding how much capital to hire: the firm will hire capital
3
National Income: Where It Comes From and Where It Goes
Questions for Review
1. The factors of production and the production technology determine the amount of output an economy can produce. The factors of production are the inputs used to produce goods and services: the most important factors are capital and labor. The production technology determines how much output can be produced from any given amounts of these inputs. An increase in one of the factors of production or an improvement in technology leads to an increase in the economy’s output.
2. When a firm decides how much of a factor of production to hire or demand, it considers how this decision affects profits. For example, hiring an extra unit of labor increases output and therefore increases revenue; the firm compares this additional revenue to the additional cost from the higher wage bill. The additional revenue the firm receives depends on the marginal product of labor (MPL) and the price of the good produced (P). An additional unit of labor produces MPL units of additional output, which sells for P dollars per unit.
Therefore, the additional revenue to the firm is P × MPL. The cost of hiring the additional unit of labor is the wage W. Thus, this hiring decision has the following effect on profits:
ΔProfit = ΔRevenue – ΔCost
= (P × MPL) – W.
If the additional revenue, P × MPL, exceeds the cost (W) of hiring the additional unit of labor, then profit increases. The firm will hire labor until it is no longer profitable to do so—that is, until the MPL falls to the point where the change in profit is zero. In the equation above, the firm hires labor until Δprofit = 0, which is when (P × MPL) = W.
This condition can be rewritten as:
MPL = W/P.
Therefore, a competitive profit-maximizing firm hires labor until the marginal product of labor equals the real wage. The same logic applies to the firm’s decision regarding how much capital to hire: the firm will hire capital