AP/ECON3240: Review Material for chapter 5
A. Required Reading: Textbook (BGLR) pp. 151-169
B. Answers to End-of-Chapter Review Questions
Review questions 1-3 on page 181.
This is an interior solution where the isoquant is tangent to the isocost line.
marginal rate of technical substitution between labour and capital is equal to the
ratio of their prices.
Any other point in the diagram is either unattainable for the
firm, or is sub-optimal, meaning that the firm can make higher profits by a
substitution of one input for another.
The firm's expansion path is the locus of
points (capital/labour combinations) that the firm chooses as it expands
Do not confuse it with the labour demand curve, which is in
The expansion path is always in labour-capital space,
which is just like the isocost and the isoquant curves.
Normally, we would expect
the expansion path to be positively sloped - as output expands, the firm hires more
It need not be a straight line, however, and in general it is not.
For an inferior factor of production, as the level of output increases (decreases),
the quantity demanded of the factor falls (increases), all other factors held
How would the firm's demand for labour be altered if labour were an
inferior factor of production?
The scale effect of a wage decrease would be
negative (production increases, so the quantity demanded of labour decreases for
an inferior factor), but the substitution effect would be positive, working in the
direction of an increase in the quantity demanded of labour.
demanded of labour would still increase. The labour demand curve still has a
negative slope. Note than in this case, the two effects work in opposing directions.
This statement is false.
See the end of the section entitled ‘the demand for labour
in the short run’.
The theory of labour demand assumes that labour is
homogenous in quality.
The negative relationship is due to a negative scale effect
and a negative substitution of a wage change on the quantity demanded of labour.
C. End-of-Chapter PROBLEMS
PROBLEMS No. 1, 2, 3, 4, 5 on Page 182.
Given that the production function is Q = 2L
, we can derive the function
marginal product of labour, which is the derivative of that function with
respect to labour input: 1/L
The next step is to derive the function for
the marginal revenue product of labour.
Assuming that the product market
is perfectly competitive, the MRP = VMP = Price*marginal product of
labour, which works out to: 10/L
(given a wage
firm’s demand curve for labour is the same as its MRP curve (provided