Problem Set 4 Solutions

# Problem Set 4 Solutions - Dept of Economics University of...

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1 Dept of Economics Fall 2010 University of Iowa Professor Sarah Frank 06E:001:SCB Principles of Microeconomics Suggested Solutions to Problem Set 4 1) [3 points] a. If a recession hits during the holiday and people elect to make their own gifts, the demand for store-bought toys would decrease. As you can see in graph 1.A.1, this will decrease the price of toys (the output). Since ±² ³ ´ ² ³ µ ² ¶·¸¹·¸ , when ² ¶·¸¹·¸ declines with no change to ² ³ , then ±² ³ will also decline. Graphically, this will cause the ±² ³ to shift down as can be seen in graph 1.A.3. Since the wage is set in the perfectly competitive labor market in graph 1.A.2, the firm is a wage-taker. Thus the quantity of labor hired will fall. 1.A.1. Toy Market (Output Market) 1.A.2 Labor Market (Input Market) 1.A.3 Representative Firm Q p Q1 P1 Q2 P2 S D2 D1 Labor S wage L w* D MRP L,1 MRP L,2 L 2 L 1

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b. This firm combines labor and capital to make toys. It can use different technologies to either be labor-intensive (use lots of labor and only a little capital) or capital-intensive (use lots of capital and only a little labor) or anywhere in between. If the price of capital equipment falls, the firm will substitute away from labor and towards capital. The firm will demand less labor at every wage, and the MRPL will shift down as can be see in graph 1.B.2. The firm is a wage-taker, so at the prevailing market wage, it will hire fewer workers than before. 1.B.1 Labor Market (Input Market) 1.B.2 Representative Firm c. If a new machine is developed that allows one worker to make more toys per hour than before, this is an example of an increase in productivity. Every extra unit of labor can now produce more units of output because of the new machine, so the MP L will increase. If the MP L increases and the price of the output stays the same, the MRP L will also increase. In graph 1.C.2, the MRP L shifts out and at the prevailing wage, the firm hires more labor. 1.C.1
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Problem Set 4 Solutions - Dept of Economics University of...

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