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Unformatted text preview: Principles of Economics I
Economics 101 Section 400 Readings Producer Theory and Markets for Factors of Production Chapter 10: Production, Technology and Costs Chapter 16: Markets for Labor and other Factors of Production Competitive Models Chapter 11: Firms in Perfectly Competitive Markets 4/26/2008 2 The Production Possibilities All Frontier other goods Bread
4/26/2008 3 Production and Resources PPF model highlights the role of productive resources in determining output levels Factors of Production or "inputs" are required to produce output More resources devoted to a particular production process generates more output (generally) Captured in the PRODUCTION FUNCTION Identifies the greatest output of a particular good that can be produced with any given set of productive resources (inputs/factors of production) 4/26/2008 4 Factors of Production (Inputs) What are these factors of production? Depends on the good being produced Often use very broad descriptions for expository purposes: Labor Land Capital Human Capital Enterprise Energy 4/26/2008 5 The Production Function
Ene rgy Enterprise Labor
Capital Production Function Output man Hu tal i Cap 4/26/2008 6 Production Function A simple example Consider: Q = 5 L Single input Linear function L = quantity of labor employed Extra unit of labor always produces the same amount of output 7 4/26/2008 Marginal Product of Labor The marginal product of labor (MPL) is the additional output produced as a result of employing the marginal unit of labor 4/26/2008 8 Output 20 Q=5L
Slope = 5 = MPL 15 10 5 1
4/26/2008 2 3 4 Labor
9 More Interesting Production Functions Functions with multiple inputs
Capital Skilled and unskilled workers Human capital Land etc. Function is nonlinear E.g. Smith's pin factory Diminishing marginal returns to labor 4/26/2008 10 An example
Q = 100 L1/2 L 1 2 3 4
100 141 173 200 MPL 100 41 32 27
11 Output 200 173 141 Q = 100 L 1/2 Slope = MPL 100 1
4/26/2008 2 3 4 Labor
12 Diminishing Marginal Product
We say that a production function displays diminishing marginal productivity in a factor (e.g. labor) if the marginal product of that factor falls as more of the factor is used 4/26/2008 13 Diminishing Marginal Product
output/ unit of L MPL L
4/26/2008 14 All other goods Diminishing Marginal Products
Lbread = 1 Lbread = 2 Lbread = 3 Lbread = 4 MPL1 MPL2 MPL3 MPL4 Bread 4/26/2008 15 How does the firm choose the amount of inputs it uses? Tradeoff: Cost of buying the marginal unit of input vs. The revenue generated by the extra output produced when employing the marginal unit of input Note: Assumed that firms care only about PROFITS Not sales volumes or market shares or share prices or revenues 16 4/26/2008 Example: Demand for Labor How much does the marginal unit of labor cost? Wage is the price of a unit of labor If the firm is a price taker in the labor market, then the cost of each additional unit of labor is W (i.e. the wage) 4/26/2008 17 Example: Demand for Labor How much is the marginal unit of labor worth to the firm?
1. Depends on how much output that marginal unit of labor generates Marginal product of labor (MPL) 2. Depends on how much revenue additional units of output generate Marginal Revenue Product of Labor If firm is a price taker in the output market, each additional unit of output sells for the given market price, P MRPL = P . MPL 4/26/2008 18 Demand for Labor If MRPL > W, then Hire more workers Increase output If MRPL < W, then decrease output Hire fewer workers Reduce output When output is infinitely divisible, then we expect profit maximization to imply: MRPL = W 4/26/2008 19 output/ unit of L $/unit of L W Demand for Labor W Labor Demand P*MPL = MRPL MPL L* L* L
20 4/26/2008 Demand for Labor The MRPL curve is the Labor Demand curve Diminishing marginal productivity implies demand curve is downward sloping Ensures unique value of L at which MRPL = W That value of L is the amount of labor optimally employed 4/26/2008 21 Labor Demand Revisited An Example Suppose firm hires L* units of labor: MPL = 10 P = $5 W = $50 MPL*P = 10 * $5 = $50 = W i.e. this is the optimal amount of labor to employ What if P = $500 and W = $5000? MPL * P = 10 * $500 = $5000 = W i.e. L* is still the optimal amount of labor to employ 4/26/2008 22 Labor Demand Revisited Labor demand depends on the wage relative to the price of output: P * MPL = W MPL = W/P W/P = the real wage Measures the amount of output that must be paid to the marginal worker 23 4/26/2008 ...
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