2 and 3 - simple one period model (consumption leisure choice)) Flashcards
Describe representative households and firms + household constraint
-We assume households and firms act rationally and have the same preferences (3 preference assumptions) we can collect them into one representative agent.
-Representative HH’s aim to maximise utility st a constraint (kinked in the simple mode). Aim for a bundle of consumption and leisure (both normal goods) which maximises utiltiy. Constaint: C = w(h - l) + pi - T.
-Representative firm aims to maximise profits st cost function. Profit max occurs when MPL = w. Firm is modelled by a prod function: Y. = Z F(K, Nd)
Properties of the production function (simple 1 period model)
-Constant returns to scale.
-Positive marginal product of l and K.
-Decreasing marginal returns to labour and capital.
-Can be combined with profit max functions to produce a labour demand curve.
Where does profit max for rep firm (one period simple model) occur?
-PI = Y - WNd
-Pi = zF(K,Nd) - WND
-Derivative of the profit function in respect to labour yields:
-Profit max occurs when real wage rate = MPL.
-MPn = w
In simple one period model (C and L) what is the effect of wage increase and non-wage income increase?
-Non wage = Dividends/interest = tax –> Pi - T. Consumption of both leisure and consumption increases, leading to higher indifference curve/utility level. Shift curve upwards (more d income)
-Wage: when real wage increases sub and income effect occur. Usually sub effect dominates and real wage increase leads to less leisure consumed and increase in the supply of labour (hours worked.) Price of consuming leisure relatively increased (opp cost of higher wage) –> more hours worked.
-Reverse is true
Effect of a TFP, z, increase on labour demand (simple one sided model)
-TFP increases shift the production function outwards as more output can be produced with the same units of input. Input’s have become more productively efficient. Reverse true.
-Increases in Z lead to increase in the demand for labour Nd, as labour is more productive. Inputs are being better utilised by firms to produce output, rational to employ more.
Describe the PPF within the one period simple model
-Economy contains two goods, c and L. PPF describes all possible combinations of c and l for which the economies resources are fully utilised, government taken out G units of consumption.
Describe a pareto optimum
A pareto optimum output level, bundle of c and l, refers to a allocation of c and l in which no other allocation can make agents better off without making at least one agent worse off.
-In the simple one period model Pareto optimum and competitive equilibrium are the same.
-In this model as all agents are represented as one household and one firm, competitive equilibrium is pareto optimal, more complex answer with complex economies/models.
Define 1st and 2nd welfare theorm
-!1st welfare theorem states, under specific conditions, a competitve outcome/equilibrium is a pareto outcome.
-2nd welfare theorem states, undere specific conditions a pareto optimum is a competitive equilibrium/outcome.
In a one period simple model, describe the effect of increase in z, TFP (WRITE OUT AND DRAW graph)
-Z increase shifts prod function upwards, greater output as inputs have become more productively efficient.
-Higher consumption, HH’s own firms, receive dividends and have higher income as a result.
-Greater Z improves the MPL as labour becomes more efficient at producing output.
-Increases in MPL lead to a rise in the real wage (labour is more productive therefore demand higher wage).
-HH;s are better off, higher w and firms become more Productively efficient.
-Higher w suggests lesiure more expensive, opp cost, therefore work more and also siggests HH are better off therefore work less.
-Whether Lab supply increases depends on sub and income effect and which dominates.
-Z increase –> consumption increase, wage increase, output increase, MPL increase. Potential lab supply increase depending on effect.
-Reverse true
describe laffer curve + linear simple model to show effect of two tax rates that yield same revenue
-Laffer curve is a graphical representation of the relationship between tax rates and tax revenue.
-Welfare is higher for the tax rate which is lower than the higher rate yet still yield same revenues.
-Simple linear one period model removes capital from the prod function, two constraints with different tax rates can be shown on the graph each yielding different indifference cuve show which is better off. Compare high and low tax encomy using graph, draw
In a one period model describe the conditions for a competitive equilbrium
-Equilbirum in a one period simple model occurs when MRSlc = MPn = w = MRTlc
-The representative household chooses a bundle of leisure and consumption optimally based on the market real wage and dividend income.
-Firm maximises profits, given the market real wage using labour input.
-All economic agents are price takers.
-G = T
In a simple one period model explain how an increase in g leads to a partial crowding out effect + show graphically
-Increase in government spending essentially crowds out private consumption, more specifically leisure through a negative income effect.
-Crowding out occurs as gov constraint is given by G = T, as the market clears higher g suggests higher value of taxes thus fall in consumption of C and L. (Also
governments spend through bonds/priv savings).
-Increase in G leads to an increase in the supply of labour ( less leisure consumed) and also rasies output through the increase in the labour input/supply. Increase in output offsets crowding out partially, thus partial effect.
-Higher G –> higher output through labour supply which partially offsets fall in consumption of C and L .
