Lecture 3 - The Long Run Model of Production and Supply Flashcards
Define the Marginal Product of Labour (MPL) and the Marginal Product of Capital (MPK)
the amount of extra output produced when labour/capital increases by one unit
What are the equations for MPL and MPK?
- MPL = F(K, L+1) - F(K,L)
- MPL = (dF(K,L))/dL
- MPK = F(K+1, L) - F(K,L)
- MPK = (dF(K,L))/dK
For the neoclassical production function, what is the assumption about returns to scale?
that there are constant returns to scale
When looking at this very simple economy, what are the 3 assumptions about the openness of the economy, the number of goods consumed/produced, and how markets and prices behave?
- single, closed economy
- one good is consumed/produced
- markets clear and prices are flexible
For the neoclassical production function, what is the assumption about marginal returns?
that there are diminishing marginal returns
What is meant by diminishing marginal returns?
as only one factor is increased, its marginal product decreases (other things equal)
What is the Cobb-Douglas production function? What does it show in relation to returns to scale and MPL & MPK?
- Y = A(K^α)(L^(1-α)), 0<α<1
- constant returns to scale
- MPL and MPK are positive, but are diminishing in L,K
In this model, what do we assume in terms of the supply of factors of production?
capital (K) and labour (L) are assumed to be in fixed supply
How do you show that something is in fixed supply when you write it?
a horizontal line above the letter
Firms hire workers at wage W, and sell output at price P; derive how MPL = W/P for firms’ demanding labour
- ∆profit = ∆revenue - ∆cost
- ∆profit = (P x MPL) - W
- keep hiring until ∆profit = 0
- 0 = (P x MPL) - W
- MPL = W/P
Firms rent capital at rate R, and sell output at price P; derive how MPK = R/P for firms’ demanding labour
- ∆profit = ∆revenue - ∆cost
- ∆profit = (P x MPK) - R
- keep hiring until ∆profit = 0
- 0 = (P x MPK) - R
- MPL = R/P
What is the equation for economic profit?
economic profit = Y - (MPL x L) - (MPK x K)
Because of Euler’s theorem, if F has CRS, then Y = F(K,L) = ?
Y = F(K,L) = (MPL x L) + (MPK x K)
What is the equation for accounting profit?
accounting profit = economic profit + (MPK x K)
For the production model, output per person in equilibrium is the product of which two key forces ?
- productivity, A (aka ‘total factor productivity’, TFP)
- capital per person, k
