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Solution Assignment 3
• Hick and Slutsky– Measurement at same utility (How you measure
utility? or What is Thai’s utility function?) or same budget (you can measure it easily)
• Old and new version– The new version measures at current situation
but you can not go back to measure at the past.
We will talk about
• Profit maximization
• Two steps decision
• Short Run and Long run
• In the short-run– With CE, price is exogenous variable– Cannot change plant/equipment scale– Fixed capital– Consider MP
pq wE rK
Why firm hire labor?
• Demand (for good and product) from consumer
• Firm acts as middleman derived demand
• Labor is different from other resource– Work situation (environment)– Social status and Opportunity– Need Respectful, Honor, Dignity
Production Function
• production function which is• Example Cobb-Douglas• Marginal Product
• Law of diminishing returns, marginal product
( , )q f E K1q E K
1 11 1
1
q E K KE K
E E E
1
(1 ) (1 )q E K E
E KK K K
Optimal Point
• Value of Marginal Product
• Value of Average Product
• Optimal at condition
• At competitive market, it is equivalent to
E EVAP p AP
Ew p MP
E EVMP p MP
E
wMC
MP
Criticism on short run theory
• Homogenous assumption about workers
• Realistic– How to calculate marginal product?– How to identify production function?
Long Run Production
• In long run, all input variable can be changed
• Isoquant and Isoprofit Concept
• Shape of Isoquant depends on ability to substitution between two inputs
Number of Workers
Capital
E*
K*
C1
C2
C*
q*
Cost MinimizationGiven q* find the lowest C “Least cost combination”
Number of Workers
Capital
E*
K*
q1 q2
C*
q3
Output MaximizationGiven C* find the highest q
If q3 = q* then C3 = C*Or If C3 = C* then q3 = q*
Number of Workers
Capital
E
q1
q2
w1 w2
F
G
W1*
x1 x2x3
Scale Effect and Substitution Effect
This is WRONG!!
Number of Workers
Capital
E
q1
q2
w1 w2
F
G
W1*
x1 x2x3
C1/r
C0/r
Scale Effect and Substitution Effect
About labor demand
• Always be downward sloping
• Decreasing in wage rate– Scale effect Increase Production
increase employment– Substitution Effect labor intensive
increase employment
• Factors will be reallocated
• More elastic of long run labor demand than short run labor demand
• Determination factors of elasticity of demand– Elasticity of substitution– Elasticity of demand for product
• increasing price lower demand decreasing labor (if labor intensive production)
– Elasticity of supply for other inputs• Depend on substitutable between inputs
Marshall’s Rule of Derived Demand
• labor demand is more elastic the greater the elasticity of substitution
• labor demand is more elastic the greater the elasticity of demand for the output
• labor demand is more elastic the greater labor’s share in total cost
• the demand for labor is more elastic the greater supply elasticity of other factors of production
Minimum Wage • Form of Policy
– A national, government – legislated minimum wage– A national minimum wage (outcome of collective
bargaining agreement)– An industry level minimum wage (industry collective
bargaining)
• Discussion– Should the minimum wage be reduced or
increased?– Is the minimum wage effective in reducing earning
inequality and poverty?– Why does a minimum wage exist?