6-4 Flashcards
What determines the prices set by firms and how are these costs calculated?
Prices set by firms depend on their costs, which in turn are determined by the production function (the relationship between inputs used and output produced) and the prices of these inputs. The production function includes factors like labor and, in reality, other elements like capital and raw materials.
Describe the simplified production function Y = AN used in economics.
In this simplified production function, Y represents output, N is employment, and A is labor productivity. This function implies that labor productivity is constant and equal to A. It’s a simplified model that doesn’t account for other production factors like capital and technological progress, which are introduced in more advanced chapters.
Why is labor productivity (A) assumed constant in the simple production function, and what is its implication?
Labor productivity (A) is assumed constant in the simple production function for ease of analysis. This assumption simplifies the relationship between output and employment, stating that one worker produces one unit of output (A = 1). However, this is an oversimplification as, in reality, labor productivity is not constant but increases over time due to factors like technological progress.
What does the production function Y = N imply about the cost of production?
The production function Y = N implies that the cost of producing one more unit of output is equal to the cost of employing one more worker at wage W. This means that the marginal cost of production, the cost of producing an additional unit of output, is equal to the wage W.
How is the price of a unit of output determined in a perfectly competitive goods market?
In a perfectly competitive goods market, the price of a unit of output would be equal to the marginal cost. Therefore, the price P would be equal to the wage W. Perfect competition assumes that firms cannot set prices above their costs, leading to prices that reflect the actual cost of production.
What is the formula P = (1 + m)W used for in price determination, and what does it represent?
The formula P = (1 + m)W is used to represent how firms set their price in markets that are not perfectly competitive. Here, P is the price, W is the cost (or wage), and m is the markup of the price over the cost. In non-competitive markets where firms have market power, m is positive, meaning that the price P exceeds the cost W by a factor of (1 + m).
