Lecture 26

Lecture 26 - Announcements Read chapters 11-13 MT scores up...

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Announcements Read chapters 11-13 MT scores up today (Wednesday)

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2 of 26 THE FIRM’S PROFIT-MAXIMIZATION CONDITION IN INPUT MARKETS In input markets, the profit-maximizing condition for the perfectly competitive firm is: P L = MRP L = ( MP L x P X ) P K = MRP K = ( MP K x P X ) P A = MRP A = ( MP A x P X ) where L is labor, K is capital, A is land (acres), X is output, and P X is the price of that output.
THE FIRM’S PROFIT-MAXIMIZATION CONDITION IN INPUT MARKETS 3 of 26 By manipulating these equations, we get: X A A K K L L P P MP P MP P MP 1 = = = In words, the marginal product of the last dollar spent on each input is the same for all inputs. If this is not the case, the firm could produce more cheaply by purchasing more of whatever input gives them higher MP/\$. Note: this is just like the utility maximization rule for consumers.

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4 of 26 THE DEMAND FOR INPUTS A FIRM EMPLOYING TWO VARIABLE FACTORS OF PRODUCTION IN THE SHORT AND LONG RUN In firms employing just one variable factor of production, a change in the price of that factor affects only the demand for the factor itself. When more than one factor can vary, however, we must consider the impact of a change in one factor price on the demand for other factors as well.
5 of 26 THE DEMAND FOR INPUTS Substitution and Output Effects of a Change in Factor Price Response of a Firm to an Increasing Wage Rate TECHNOLOGY INPUT REQUIREMENTS PER UNIT OF OUTPUT UNIT COST IF P L = \$1 P K = \$1 ( P L x L ) + ( P K x K ) UNIT COST IF P L = \$2 P K = \$1 ( P L x L ) + ( P K x K ) K L A (capital intensive) 10 5 \$15 \$20 B (labor intensive) 3 10 \$13 \$23 The Substitution Effect of an Increase in Wages on a Firm Producing 100 Units of Output TO PRODUCE 100 UNITS OF OUTPUT TOTAL CAPITAL DEMANDED TOTAL LABOR DEMANDED TOTAL VARIABLE COST When P L = \$1, P K = \$1, firm uses technology B 300 1,000 \$1,300 When P L = \$2, P K = \$1, firm uses technology A 1,000 500 \$2,000

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6 of 26 THE DEMAND FOR INPUTS factor substitution effect The tendency of firms to substitute away from a factor whose price has risen and toward a factor whose price has fallen. output effect of a factor price increase (decrease) When a firm decreases (increases) its output in response to a factor price increase (decrease), this decreases (increases) its demand for all factors.
7 of 26 INPUT DEMAND CURVES FOUR THINGS CAN CAUSE SHIFTS IN FACTOR DEMAND CURVES If product demand increases, product price will rise and marginal revenue product (factor demand) will increase —the MRP curve will shift to the right. If product demand declines, product price will fall and marginal revenue product (factor demand) will decrease—the MRP curve will shift to the left. 1. The Demand for Outputs

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This note was uploaded on 06/21/2009 for the course ECON 2005 taught by Professor Zirkle during the Fall '07 term at Virginia Tech.

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Lecture 26 - Announcements Read chapters 11-13 MT scores up...

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