lecture11 - Microeconomics I - Lecture #11, April 28, 2009...

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Unformatted text preview: Microeconomics I - Lecture #11, April 28, 2009 11 PPF, Comparative Advantages 11.1 The Robinson Crusoe economy During this analysis Robinson plays two roles: he is both a consumer and a producer. Robinson can either lie on the beach and do nothing, i.e. consume leisure or he can spend time working, gathering coconuts. The more coconuts he gathers the more he has to eat, but the less time he has to relax. Robinsons preferences for leisure and coconuts are depicted on the picture below. We also illustrated typical Robinsons production function that describes the relationship between how much Robinson works and how many coconuts he gets. The more Robinson works the more coconuts he gets but due to diminishing returns to labor the marginal product of labor decreases as the hours of labor increase. How much will Robinson work and how much he will consume? The optimum combination of labor and consumption is a point where the highest indifference curve touches production function. The production function describes Production possibilities frontier (PPF) - maximum possible output for a given level of input(s). The set below this function is production set. At this point, the slope of the indifference curve must equal the slope of the production function by the standard argument: if they crossed, there would be some other feasible point that was preferred. This means that the marginal product of an extra hour of labor must equal the marginal rate of substitution between leisure and coconuts. If the marginal product were greater than the marginal rate of substitution, it would pay for Robinson to give up a little leisure in order to get the extra coconuts. If the marginal product were less than the marginal rate of substitution, it would pay for Robinson to work a little less. Market approach: Robinson the firm Each evening, Crusoe decides how much labor it wants to hire the next day, and how many coconuts he wants to produce. Given a price of coconuts of 1 and a wage rate of labor of w , we can solve 56 the firms profit- maximization problem: max C = C- wL For a given level of profit , the formula = C- wL or C = + wL describes the isoprofit lines- all combinations of labor and coconuts that yield profits of . Crusoe will choose a point where the profits are maximized. As usual, this implies a tangency condition: the slope of the productionthe profits are maximized....
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lecture11 - Microeconomics I - Lecture #11, April 28, 2009...

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