Income refers to the payments made to factors of production to produce output, including wages paid to labor and interest and dividends paid to capital. Output refers to the total value of goods and services produced by these factors of production. Under the usual rules of income accounting, the income received by factors of production equals the value of what is produced. Hence, these terms can be used interchangeably. In the highly stylized world of supply and demand shown in figure 2-2, assume that businesses always make optimal investment decisions and that all types of capital earn the same competitive return at the margin.
Economists refer to such a world as neoclassical.
Consider point A in figure 2-2, the intersection of the demand curve and Supply 1. In this stylized neoclassical world, this intersection repre- sents an equilibrium at which every business is buying the ideal amount of computing equipment, given the price. If returns were not equalized at the cost of capital, then firms would be better off by spending more on investments that had returns higher than the cost of capital and less on investments with returns lower than the cost of capital. Now, suppose technological improvement in semiconductors shifts the supply curve out to Supply 2 in figure 2-2. As the price falls and it becomes profitable to deploy computers for applications further down the demand curve, the quantity of computer purchases rises from Qua to the new optimal level of purchases Q2.