econ151a_winter2010_lecture8_topost

econ151a_winter2010_lecture8_topost - Employment Decisions...

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Employment Decisions (Labor Demand) in the long run In the long run, the firm can vary capital (and other inputs) as well as labor. In long run, firm must decide how to combine labor and capital in minimum cost way Need to use isoquants defined over labor and capital, and isocost lines
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Defn: Isoquant: all possible combinations of inputs (labor & capital) that can produce the same level of output Assume: Isoquants are downward sloping Isoquants do not intersect Higher isoquants (NE) are associated with higher output Isoquants are convext (diminishing MRTS)
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K L q0 q1
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Slope of isoquants = MRTS MRTS: marginal rate of technical substitution (of labor for capital) Slope of isoquant is equal to MP E /MP K Slope describes the amount of capital required to hold output constant when giving up one unit of labor Convexity: comes from assumption that MRTS declines as we move down (to SE) the isoquant
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Isocost curves Firms costs of production are described by amount of inputs times their prices C = wE + rK To plot in K (vertical), E(horizontal) space, rewrite as: K = C/r (w/r)E Slope is ratio of factor prices
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K L C 0 /r C 0 /w C 1 /w C 1 /r Slope = -w/r
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Cost minimization To minimize costs of production, firm must achieve output level q0 (on an isoquant) at the lowest possible isocost curve This will happen at tangency, or where MP E /MP K = w/r OR MPE/ w = MPK/ r
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K L C 0 /r C 0 /w C 1 /w C 1 /r q0 L* K*
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Profit maximization Tangency of isocost & isoquant tells how to achieve quantity of output q0 at minimum cost (MP E /MP K = w/r) Firm must also find profit maximizing level of output This is given by MC = MR, or w=p*MP E and r=p*MP K
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Long-run Demand for Labor Now, use these profit maximizing rules to determine how demand for labor (and capital) change as the wage changes: THIS gives long-run demand for labor function Reduction in the wage will affect conditions for optimal output, and for lowest-cost method of producing that output w=p*MP E and MP E /MP K = w/r
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K L C 0 /r C 0 /w q0 L* K* Consider effect of wage change
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K L C 0 /r C 0 /w’ q0 L* K* INCORRECT: Effect of wage change (wage falls) C 0 /w THIS change in isocost holds costs constant not necessary
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This note was uploaded on 02/14/2011 for the course ECON 151A taught by Professor Miller during the Spring '06 term at UC Davis.

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econ151a_winter2010_lecture8_topost - Employment Decisions...

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