Lecture 3: Market Demand and Production Flashcards
How is a demand curve constructed?
Using the tangency conditions from the optimal choice:
1) MRS = exchange rate (pa/pb
(2) All income is spent PaA* + PbB* = m
Normal goods:
Must obey the law of demand
Income effect reinforces substitution effect
Substitution effect always negative
Inferior goods:
Often (but not always) obey the law of demand
Income effect in opposition to substitution effect
But the substitution effect can outweigh the income effect
Giffen goods:
Never obey the law of demand
Income effect in opposition to substitution effect
Income effect is large enough to outweigh the substitution effect
Rare, possibly nonexistent
How to construct an individual consumer’s demand schedule?
Solve their constrained optimization problem (how to maximise their utility subject to budget constraints)
How to construct the aggregate demand schedule?
Sum all consumer demands
What is the theory of production?
Firms will organise their production so as to maximise profits
Long run production function
All factors of production (labour L and capital K) are variable
Short run production function
At least one factor of production is fixed (generally K)
What is the marginal product of labour?
The amount of output an additional worker adds
MPL = Change in f(L) / change in L = slope of the tangent at point on f(L)
How does the marginal product affect the average product?
Cuts the the average product at its maximum - pulls the average up
Total cost in short run?
TC = wL + rK = FC + VC
(rK = FC) fixed cost as K can’t be varied in short run
(wL = VC) variable cost as L is variable in short run
Average variable cost =
VC/Q
wL/Q
wL/f(L)
w/APL
Marginal cost =
Change in total cost/quantity
Change in variable cost/quantity
What do AVC and MC curves do?
Fall then rise
