Intermediate Macroeconomics: Equilibrium in a Production Economy

In the previous section we studied equilibrium in a particularly simple world – an endowment economy. This was useful for getting intuition about what determined the real interest rate, but lacked realism. In this section we endogenize supply. The concept of equilibrium is identical to before, but the set up is more interesting. Now we have firms that produce output using capital and labor, and households that consume, save, and supply labor. In addition to the goods market that must clear, we have another market – the labor market. We have several different exogenous variables and can examine how changes in these variables affect the endogenous variables of the model.