Lecture 3 - National Income

Terminology

Y = A x F(K,L)

Y: Output, real GDP
A: Technology
K: Capital
L: Labor

By nature of the definition of GDP, Y (output) = total income = labor income + capital income

Labor income is salaries, benefits, etc given as compensation to laborers.
Capital income is corporate profits and rental income. Also includes depreciation. Shouldn't this be subtracted from capital income??

Labor income share is the percent of Y that is labor income = total labor income/Y = 0.7
Capital income share is 0.3.

Paul Douglas found that the labor income share is very consistent at 0.7.

If Z=X/Y, how does the growth rate of one of the factor, X or Y, impact the growth rate of the ratio, Z? The answer is: %ΔZ = %ΔX - %ΔY

Let total labor income = (W/p) L, where (W/p) is real wage (i.e. wage/price index) and L is the # of workers.

Let labor productivity = Y/L; i.e. output per worker

Then labor income share = [(W/p)L]/Y = (W/p)/(Y/L) = 0.7

Since Douglas observed that this ratio doesn't change,
%δlabor income share = 0 = %Δ(W/p) - %Δ(Y/L)
and therefore,
%Δ(W/p) = %Δ(Y/L)

Income inequality. Look at the labor market.

You can increase production by adding labor, adding machinery or adding factories. When adding labor, you need to look at the marginal productivity curve.

MP_L = marginal productivity of labor = ΔY / ΔL
All things being equal, how much additional output with be produced by adding one more worker.

Examples: Adding more and more computers eventually gives you less and less benefit per computer added. Adding workers at a crowded ice cream shop eventually cuts down the line to a point where adding additional workers does not provide any faster service.

If you hire one more worker, the benefit to the owner is more cheese. By how much? By MP_L. In terms of $, this is MP_L x P, where P is the unit price of the product. This is the marginal revenue product.

Labor Demand Curve

Why is there wage inequality between skilled and unskilled labor workers?
Supply-side factor explanation. There are two different markets. There were a large number of unskilled immigrants, women and teenagers who entered the US job market in the 1970s. The rightward shift in the labor supply curve of unskilled workers was much greater than the shift in the labor supply curve of skilled workers.

The rightward shift for skilled laborers should have caused their real wages to go down. Why didn't we see that?

For that, we need to look at the demand-side factor explanation. Technological advances favor the skilled workers more than it did the unskilled workers. This skill-biased technological progress raised the real wages of skilled workers to increase and those of unskilled workers to decrease.

Some argue that the international trade has caused the income inequality. At the same time, US companies relocated outside the US, causing loss of jobs. The bargaining power of companies increased and they were able to keep the wages in the US low.

Observation: Even those companies that were not effected by international trade have experienced depressed wages for unskilled labors. This indicates that although int'l trade may be a factor, it is not the primary factor. Remember also that int'l trade is only 30% of US GDP. Skill-based technological progress is a more important factor.

Refer to table (5) Widening Wage Inequality in the US by Autor, Katz and Kearney. Their study found that nearly 2/3 of the relative increase in demand for college or more educated workers can be explained by rising workplace computer use.

Readings

Full class on April 30. Half class on June 4th.

The richest 1% of the population has dramatically increased. Bill Gates, David Beckham. There's a huge gap between #1 and #2.

Who benefitted from the Black Death? Common workers.

Technology replaced routine jobs, but it created many many other jobs.

We find rising income inequality even in developing nations.

When Bush came into office, he imposed a 30% tariff on steel. It saved 5000 US jobs. What was the cost to the whole economy? According to some, the increase cost 50,000 jobs in other areas.

National Income: Expenditure Side

How can we possibly finance the trade deficit? How do tax cuts work?

Saving-Investment model (closed economy)

Y = C + I + G (no NX factor because it's a closed economy)

Consumption: C = C((Y-T), (Y-T)f,wealth, r)

where
Y-T = disposable income = income-taxes = C+Sp (private savings)

naturally, if you increase disposable income, consumption will increase

MP_c = marginal propensity to consume = ΔC/Δ(Y-T)
i.e. if you have one more dollar in your pocket, how much more will you spend?
0 < MP_c < 1

This is almost a linear relationship and the slope is about 0.96.

Consumption is affected by future expected income. That's the (Y-T)f factor.

One-time tax rebates (like the recent one) are more comparable to a bonus than a salary increase. We don't expect a large increase in consumption based on this one-time event.

The Wealth factor is accumulated savings. There was a strong correlation between the housing boom and consumption.

Real Interest Rate, r = i - π
where i = nominal interest rate and π = inflation
This is known as the Fisher equation and is based on an arbitrage argument.

When the real interest rate goes up, the real cost of borrowing goes up, which reduces consumption. And vice-versa. Ex: When mortgage interest rates went down, people had more money in their pockets and consumption increased.

Investment

I = I (r, Y, Yf, tax policy)
Factor correlations: -, +, +, ?

Example:
r = 10%
rate of return = 8%
don't invest!

But if rate of return > r, then companies will invest. Therefore, when interest rates are low, there are more profitable opportunities.

When output level, Y, is high, it's a good time to invest.

Tax policy can impact investment in either direction.

Total Savings-Investment Model:

Y = C+I+G
C = C(Y-T)
I = I(r)
Therefore Y-C-G = I
(Y-T-C)+(T-G) = I
private savings Sp + govt savings Sg (approximate) = I

call it national savings, S. S=I

Asumme full employment and level of output
Ybar = AxF(Kbar, Lbar)

S = Sp+Sg
S = Ybar - Tbar - C(Ybar-Tbar) + (Tbar-Gbar)

Everything is constant so S is constant (verticle).

S can be viewed as the supply of loanable funds and I is the demand for loanable funds. The equilibrium interest rate is where the two curves meet.