Lecture 4| Consumer Theory 4 Flashcards
What is revealed preference? Which bundles are preferred to the revealed preference of bundles? (What theory is applied?)
If on the budget line, there are two bundles A and B. If bundle A has been preferred to bundle B, then it’s been revealed that A has been preferred to B.
Any region outside of bundle A is better than bundle A. (more is better theory is applied)
What is the optimal bundle given by? What does weakly better off mean?
The optimal bundle is given by the tangency condition, the slope of the budget line
Weakly better off refers to how on the new budget set, customer can still choose bundle A or any other points on the budget line
What is the slope of the budget set?
Slope of budget set= (minus) wage/price of other goods
What does the substitution effect mean? (what happens in the substitution effect?) What effect does the income effect have? What makes up total effect?
The substitution effect basically means that as wages increase, the relative price of leisure (in terms of other goods foregone) goes up; therefore, you substitute to less leisure (i.e. to more work)
The income effect means that when wages increase, you income will increase too. If wage and leisure are both normal goods, then as income increases you would want of more goods. Therefore, the income effect means you want more leisure.
Total effect= substitution effect + income effect
What makes the supply curve bend backwards or what happens when it goes forward? (when wages increase)
When wages increase, if the substitution effect is bigger than the individual will want to work more hours and take less time for leisure. (forward supply curve)
When wages increase, if the income effect is higher, an individual would want to work less hours and have more time for leisure (backward supply curve)
In the situation of tax, what makes the supply curve go forward and what makes it bend backwards?
w/price & (1-tax)(w/price) important metrics to know
When tax occurs, if the substitution effect is bigger, the labour supply curve will bend backwards (for individuals who want to work more)
\When tax occurs, if the income effect is bigger, the labour supply curve will slope up (for individuals who want to work less)
Their utilities however will defs decrease
What are the two possible scenarios regarding tax?
If everyone was hard working then tax revenue would be higher with higher tax
If everyone didn’t like to work as hard, then there would be a trade-off, increasing tax will increase per dollar earned, but people will respond to this by working less
What is producer theory? How is producer and consumer theory similar?
Producer theory: studies how firms make production decisions - how to choose inputs correctly to minimise costs
Similarities: Production technology (PT) -> Preferences (CT) Cost constraints (PT) -> Budget constraints (CT) Input choices (PT) -> Consumption choices (CT)
What do firms do ? (What do they eliminate and put in place)
Firms offer a means of coordination that is extremely important and is sorely missed if workers operated independently
- eliminates risk for every worker to negotiate every task that he or she will perform and bargain over fees paid for those tasks
- Firms can avoid this sort of bargaining by having managers that direct the production of salaried workers- they tell workers what to do and when to do it and workers paid a weekly or monthly salary
What types of inputs do firms convert? What kind of outputs does that turn into?
Firms convert inputs such as:
labor: skilled workers and less skilled workers
capital: machinery ,land, buildings
and
materials
These turn into outputs: goods or services for sale
Inputs can be called factors of production
What does the production function q=f(K,L) describe or show? How does outputs respond to short run and long run?
The production technology is described by the production function q=f(K,L) , possible outputs that can be produced with a certain with a given amount of K and L
How output responds to changes in the amount of inputs:
Short run: A period of time such that at least one factor of production cannot be changed. This factor is called fixed input. The other inputs that can be changed in the short run are called variable inputs.
Long run: a period of time needed so that firms can vary all inputs (so all inputs are variable)
What is a short run and long run example?
If a woman is unhappy, then she should get a haircut, if not change her apartment or still unhappy change her boyfriend.
The production function:
hair cut, apartment, boyfriend -> happiness
In the long run: can change apartment, boyfriend and haircut
In the short run: cant change apartment (lease hasnt been cancelled BC OF EXPIRY ON LEASE)
What are some properties of the production function in the short run? What does average labour of labour and marginal product of labour both rely on?
In the short run, usually the capital is fixed: K=K\bar and labour is variable
Short run production function: q=f(K\bar, L)
Average product of labour: Output per unit of labour used, keeping capital constant:
AP (small) L= q/L | K=K\bar
Marginal product of labour: additional output produced when one extra unit of labour is employed:
MP (small) L = (\inc)q/(\inc)L | K=K\bar = change in q/change in L
They both rely on capital, when capital is high they tend to be higher
How do you calculate the slope of the average product?
average product= slope of the line from the origin. First increases then decreases
AP (small) L= q/L | K=K\bar
Hoe do you calculate the slope of the marginal product?
additional output produced when one extra unit is employed
Marginal product: slope of tangent line= first increases then decreases (small straight tangent lines)
MP (small)L= (\inc)q/(\inc)L | K=K\bar = change in q/ change in L
When does diminishing of marginal product of labour settle in? What is the law of diminishing marginal returns?
Marginal product of labour:
when labour input is small, MP(small) L increases when labour increases due to specialisation
When labour input is large, MP(small) L decreases when labour increases,; when there are too many workers some become less effective
Law of diminishing marginal returns:
when more and more labour is hired but capital is fixed, marginal product of labour will eventually start decreasing
What is the relationship between marginal and average products?
When MPL is above the APL, the APL is increasing
When MP is below the AP, the average product starts to decrease
When MP is equal to AP, the average product reaches its maximum
MP crosses AP from above where AP is at its maximum
In the long run, describe the marginal product of labour and marginal product of capital
Context: The production technology is described by the production function q=f(K,L). It shows the maximum possible output q that can be produced with a given amount of inputs K and L.
The marginal product of labour shows an increase in output due to one unit increase in labour holding capital fixed:
MPL= (\inc)q/(\inc)L| K=K\bar = change in f(K,L)/ change in L|K=K\bar = change in q /change in L = change in f(K,L)
In the long run, describe the marginal product of labour and marginal product of capital
Context: The production technology is described by the production function q=f(K,L). It shows the maximum possible output q that can be produced with a given amount of inputs K and L.
The marginal product of labour shows an increase in output due to one unit increase in labour holding capital fixed:
MPL= (\inc)q/(\inc)L| K=K\bar = change in f(K,L)/ change in L|K=K\bar = change in q /change in L = partial derivative of f(K,L)/ partial derivative of L
The marginal product of capital shows an increase in output due to one unit increase in capital holding labour fixed
MP_K= (change in q)/ (change in K) | L=L\bar = (change in f(K,L) / (change in K) | L=L\bar = (partial derivative of q)/ (partial derivative of k) = (partial derivative of f(K,L) )/ (partial derivative of K)
Most production technology exhibit diminishing marginal products
What is an isoquant? What is the slope of an isoquant called?
Isoquant: set of all possible combinations of inputs that are just sufficient to produce a given amount of output f(K,L)= q
It’s just like indifference curves for consumers
Slope of an isoquant is called the marginal rate of technical substitution (MRTS) : measures the rate at which one input can be substituted for another without changing the amount of output produced. It is equal to minus the slope of the isoquant
slope= change in K/change in L (slope is negative, MRTS is positive)
Change in q = (\incMP_K)(\incK) + (\incMP_L) * (\inc*L) = 0
How are isoquants similar to indifference curves?
Isoquant and indifference curves- both downward sloping and convex. The slope of the isoquant at any point measures the marginal rate of technical substitution - the ability of the firm to replace capital with labor while maintaining the same level of output
MRTS is equal to the negative of the slope of the isoquant
What happens when inputs are perfect substitutes?
- isoquant are straight lines (downward sloping)
- the rate at which capital and labor are can be substituted for each other to produce the same output is the same no matter what level of input is used
MRTS is constant
example: q= 3K + 5L
What happens when inputs are perfect complements?
Isoquants are L-shaped
Labour and capital need to be used in exact proportions - adding more capital only or more labour only does not increase output
MRTS is 0 on the horizontal part and infinite on the vertical part
Example: q=min{3K, 5L}
What are properties of the production function q=f(K,L) in the long run: Returns to scale
What happens when we increase all inputs by factor t>1?
for example double or triple?
constant return to scale: f(tK, tL) = tf(K,L) - replication
increasing returns to scale: f(tK, tL)> tf(K,L) - benefits from specialization
decreasing returns to scale: f(tK,tL) < tf(K,L) - replication is not possible
review graphs in notes
