Chapter 3: National Income: Its Production, Distribution, and Allocation

Simplifying assumptions in this chapter:

· The capital stock, the labor force, and production technology are fixed. (drop in chapters 4&5)

· The labor force is fully employed (drop in chapter 6)

· We ignore the effect of money (drop in chapter 7)

· We assume a closed domestic economy, without trade or other international transactions (drop in chapter 8)

· We ignore the short-run effect of sticky prices and wages (drop in chapters 9 - 13)

1. The Circular Flow of Income Circular flow model

a. Motives of different sectors

b. Linkages among different sectors

2. The Production of Goods and Services

a. The aggregate production function

b. The role of factors of production (capital, labor)

c. The role of technology (how we combine inputs to produce output)

3. Distribution of Goods and Services

a. The role of factor prices as compensation

b. The influence of competition

c. The firm’s demand for factors, a derived demand

d. The demand for labor (MPL)

e. The demand for capital (MPK)

f. The division of national income

4. The Demand for Goods and Services

a. Components of spending

b. Consumption

c. Investment

d. Government purchases

5. Equilibrium in the Goods Market

a. Injections equal leakages

b. The role of interest rates

c. Equilibrium in the financial markets: supply and demand for loanable Funds

d. Changes in savings rate

e. The effects of fiscal policy

(1) effect of more government spending

(2) effect of a decrease in taxes

f. Effect of investment spending

(1) effect on aggregate demand

(2) effect on aggregate supply

g. Effect of interest rates on savings (the identification problem)