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PP2 - Practice Problems on Production Function and Labor...

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Practice Problems on Production Function and Labor Market 1- What is a production function? What are some factors that can cause a nation’s production function to shift over time? What do you have to know besides an economy’s production function to know how much output the economy can produce? A production function shows how much output can be produced with a given amount of capital and labor. The production function can shift due to supply shocks, which affect overall productivity. Examples include changes in energy supplies, technological breakthroughs, and management practices. Besides knowing the production function, you must also know the quantities of capital and labor the economy has. 2- The production function slopes upward, but its slope declines from left to right. Give an economic interpretation of each of these properties of the production function. The upward slope of the production function means that any additional inputs of capital or labor produce more output. The fact that the slope declines as we move from left to right illustrates the idea of diminishing marginal productivity. For a fixed amount of capital, additional workers each add less additional output as the number of workers increases. For a fixed number of workers, additional capital adds less additional output as the amount of capital increases. 3- Explain why the profit-maximizing level of employment for a firm occurs when the marginal revenue product of labor equals the nominal wage. How can this profit- maximizing condition be expressed in real terms? The marginal revenue product of labor represents the benefit to a firm of hiring an additional worker, while the nominal wage is the cost. Comparing the benefit to the cost, the firm will hire additional workers as long as the marginal revenue product of labor exceeds the nominal wage, since doing so increases profits. Profits will be at their highest when the marginal revenue product of labor just equals the nominal wage. The same condition can be expressed in real terms by dividing through by the price of the good. The marginal revenue product of labor equals the marginal product of labor times the price of the good. The nominal wage equals the real wage times the price of the good. Dividing each of these through by the price of the good means that an equivalent profit- maximizing condition is the marginal product of labor equals the real wage. 4- What is the MPN curve? How is the MPN curve related to the production function? How is it related to labor demand?
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