Unformatted text preview: Principles of Economics I
Economics 101 Announcements Readings: Chapter 5: jointly consumed goods Chapter 10: Production, Technology and Costs Chapter 16: Markets for Labor and other Factors of Production Discussion Sections this week New assignment available on Ctools later this evening Quiz this week Taxonomy of Goods
Rivalry in Consumption Private Good food haircuts highways Common Property Resource common pasture land QuasiPublic Good Club Good websites swimming pool Public Good radio broadcast national defense Difficulty Excluding Consumers Common Property Resources Usually associated with a negative externality Exclusion is costly, so many people can use the resource There is rivalry, so additional users impose negative externalities of existing users Additional users ignore those externalities Resource is overused or congested "The Tragedy of the Commons" Solution? Problem lies in assignment of property rights; and excludability If you can potentially exclude users, then you can make them pay to use the resource Charge a price equal to the externality imposed But if exclusion costs are very high, this solution is not available Example: Road Pricing Imposing different tolls on different roads gives drivers incentive to change their routes High tolls imposed where congestion costs are high Zero tolls charged where congestion costs are negligible Requires technology that excludes those who don't pay (or punishes those who use without paying) E.g Singapore's road pricing experience Tolls vary by location Tolls vary by time Tolls are easily amended in response to changing traffic patterns Network Externalities Converse of the common property case Additional users provide positive externalities to existing users Potential market failure: underinvolvement in a given network, and too many networks available The Production Possibilities All Frontier other goods Bread 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) 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 The Production Function
Ene rgy Enterprise Labor
Capital Production Function Output man Hu tal i Cap 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 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 Output 20 Q=5L
Slope = 5 = MPL 15 10 5 1 2 3 4 Labor 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 An example
Q = 100 L1/2 L 1 2 3 4 Q
100 141 173 200 MPL 100 41 32 27 Output 200 173 141 Q = 100 L 1/2 Slope = MPL 100 1 2 3 4 Labor 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 Diminishing Marginal Product
output/ unit of L MPL L All other goods Diminishing Marginal Products
Lbread = 1 Lbread = 2 Lbread = 3 Lbread = 4 MPL1 MPL2 MPL3 MPL4 Bread 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 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) 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 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 output/ unit of L $/unit of L W Demand for Labor W Labor Demand P*MPL = MRPL MPL L* L* L 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 ...
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