The demand curve for current labour is the representative firms marginal

The demand curve for current labour is the

This preview shows page 9 - 12 out of 25 pages.

The demand curve for current labour is the representative firm’s marginal product of the labour schedule. Firms will hire current labour until MPN equals the current wage rate, MPN = w . The curve can be seen to slope downwards because the marginal product of labour declines as the labour input increases. In this figure, we show the representatives firm’s demand curve for labour, N d . The Current Demand Curve for Labour Shifts Due to Changes in Current Total Factor Productivity z and in the Current Capital Stock K The current demand curve for labour shifts due to changes in current total factor productivity z and in the current capital stock K. An increase in z or K shifts the curve to the right reflecting the resulting increase in the marginal product of labour. The frim chooses
Image of page 9

Subscribe to view the full document.

labour demand in the future period in a similar way to its choice of current-period labour demand. The Representative Firm’s Investment Decision A key principle in economic decision making is that the optimal level of an economic activity is chosen so that the marginal benefit of the activity is equal to its marginal cost. We let MC(I) denote the marginal cost of investment for the firm where MC(I) = 1. The marginal cost of investment is 1, as the firm gives up one unit of current profits for each unit it invests. The marginal benefit from investment, denoted by MB(I) , is the marginal product of future capital plus the quantity of capital that will be left in the future after depreciation, all discounted back to the present value of profits, V . MB(I) = MP' K + 1 d 1 + r Optimal Investment Rule for the Firm The firm’s optimal investment rule is obtained by equating the marginal benefit and marginal cost of investment: MP' K + 1 d 1 + r = 1 This can be rewritten as MP’ K – d = r The above equation states that the firm invests until the net marginal product of capital, MP’ K – d, is equal to the real interest rate. The net marginal product of capital is the marginal product of capital after
Image of page 10
taking account of the depreciation of the capital stock. The intuition behind the optimal investment rule is that the opportunity cost of investing in more capital is the real rate of interest, which is the rate of return on the alternative assets in this economy. In this model there are two assets: 1. Bonds are traded in the credit market 2. Capital held by representative firms If the firm invests in capital, it is giving up the opportunity to lend in the credit market where it can earn a real rate of return ?. Effectively, the representative consumer holds the capital of the firm indirectly, because the consumer owns the firm and receives its profits as dividend income. From the consumer’s point of view, the rate of return that they receive between the current and future periods when the firm engages in investment is the net marginal product of capital. As the firm acts in the interests of the consumer, it would not be optimal for the firm to invest beyond the point where
Image of page 11

Subscribe to view the full document.

Image of page 12
  • Summer '18

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes