Macroeconomics: an Open Economy Approach - Coursework Example

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The level of production is determined by the factor inputs of labor and capital. Increasing labor while holding capital constant leads to an increase in output until a certain point is reached where an extra amount of labor unit produces a proportional decrease in output. This is the law of diminishing returns. The supply of work is an increasing function of the real wage because as more labor is available, the cost of effort becomes cheap and more people are hired while as work supply decreases, the demand for the same goes high and the real wage goes up (Pentecost, 2000). These fluctuations necessitate an equilibrium that is achieved when demand equals the supply. Equilibrium in the labor market will be influenced by consumption rate, taxation rate, disposable income, and investment rate.

The rational expectation is a theory that explains that an individual’s expectations do not differ systematically from the outcomes. People in this case make decisions depending on their rational outlook, information available, and experiences.