The Supply Side of the Economy

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Instructions

1. Read Scenario A (Uploaded) and work through this example. It is necessary to do this before moving on to steps 2 and 3.

2. Download and PRINT the graphing template (Uploaded). Please hand draw the graphs on this graphing template that are to be used in Homework 3 questions. When finished, please attach as a SINGLE multi-page pdf file.

3. Assignment Homework 3 (Uploaded) is composed of multiple choice questions, fill-in-the-blank questions and graphing. There are 30 questions total.

* FOR FILL-IN-THE-BLANK questions: None of the answers will have decimals. Some of the answers may be negative. For example, if your answer is 2, enter 2 with no decimals. If your answer is -$1,000 enter -1000 with no decimals. Do not enter any extra spaces, do not enter commas or $ or % symbols.

* FOR GRAPHING QUESTIONS: when graphing make sure you fully label everything you add to the graph, as was done in the lectures. If you don’t label everything, you will lose points. Use different colors when adding to your graphs if possible – this will make your graphs easier to read. You must draw your graphs on the graphing template provided.

SCENARIO A – Consider a firm that has the following relationship between labor and output, i.e., a production function. Along this production function, we hold land, capital (K) and technology (total factor productivity) fixed.

TABLE A- The current wage is $150 and the price of output (Q) is $20.

L Q MPL MRP Marginal Profit Total Profit

0 0 —— ——- ——————– 0

1 8 8 160 10 10

2 20 12 240 90 100

3

28 8 160 10 110

4 35 7 140 -10 100

5 41 6 120 -30 70

6 45 4 80 -70 0

*note that the values in the shaded part of the table are provided, but you should able to calculate all of these values. You will need to fill in similar tables in homework 3, so make sure you are comfortable with these calculations NOW.

It should be clear from this table that the profit maximizing amount of labor is 3, the profit maximizing amount of output (Q) is 28 and maximum profit is $110.

A sketch of this firm’s production function, including the profit maximizing Q and L combination (labeled point A) is shown below. You should be able tohand sketchthis production function using the information from table A.

A sketch of this firm’s W/MRP labor market diagram is shown below. The profit maximizing point is labeled (point A) and the blue shaded area is the profit. You should be comfortable handsketching the graph below using the information from table A.

Scenario A will be your starting point for homework 3. You will be examining several alternative scenarios for this firm (Scenario’s B, C and D), and each time you will compare the new situation to the original case in scenario A.

GRAPHING TEMPLATE – print this document and hand draw your answers on the graphs provided. Then scan your work into a SINGLE multi-page pdf.

Graph 1:

Graph 2:

Graph 3:

Graph 4:

Graph 5:

1.SCENARIO B: Suppose that due to favorable economic conditions, the price that this firm can sell its product for rises to $22.

For question 1. Fill in Table B – Each box is worth ½ point for a total of 9 points for Table B

TABLE B- The wage is still $150 and the price of output (Q) is now $22.

L Q MPL MRP Marginal Profit Total Profit

0 0 —- —- ————- 0

1 8 8 $

$

$ 2 20 12 $

$

$ 3 28 8 $

$

$ 4 35 7 $

$

$ 5 41 6 $

$

$ 6 45 4 $

$

$

Use Scenario B/Table B to answer the questions 2 – 4 below.

2.(3 points) The profit maximizing output (Q) is .

3.(3 points) The profit maximizing level of labor (L) input is workers.

4.(3 points) The maximum profit for this firm is .

DOWNLOAD AND PRINT GRAPHING TEMPLATE (available in the homework 3 instructions). This template already shows the outcome from scenario A. You will be adding results from scenario B to these graphs.

5.(2 points) Using Scenario B/Table B, go to Graph 1. Label the new profit maximizing Q and L combination on the production function as point B.

6.(3 points) Using Scenario B/Table B, go to Graph 2 and draw this firm’s new MRP curve (remember that MRP = P* MPL, and since price changed, we know we have a new MRP curve!). Shade in the new area of profit. Also label the new profit maximizing point as letter B.

7.(3 points) Using Scenario B/Table B, draw this firm’s Supply curve on Graph 3. You should construct a supply curve as we did in lecture with point A representing the original price and output combination from scenario A (original price was $20 combined with the profit maximizing Q of 28) and point B representing the price and output combination after the change in economic conditions in Scenario B (price rose to $22, and the profit maximizing Q you found in your answer for #2 above). Connect the two points and label your supply curve.

8.(2 points) When comparing Scenario A to Scenario B, the firm now hires _______ workers.

A) more

B) fewer

9.(2 points) When comparing Scenario A to Scenario B, the firm now produces _____ output.

A) more

B) less

10.(2 points) When comparing Scenario A to Scenario B, the firm now earns _______ profit.

A) more

B) less

SCENARIO C – We return to the original conditions (from scenario A) and now we let wages change. In particular,an increase in labor supply lowers the wage that the firm needs to pay to $130.

For question 11. Fill in Table C – Each box is worth ½ point for a total of 6 points for Table C

TABLE C- The wage has changed to $130 but the price of output (Q) is back at its original value of $20.

11.

L Q MPL MRP Marginal Profit Total Profit

0 0 —– —– ———— 0

1 8 8 $160 $

$ 2 20 12 $240 $

$ 3 28 8 $160 $

$ 4 35 7 $140 $

$ 5 41 6 $120 $

$ 6 45 4 $80 $

$

Use Scenario C/Table C to answer the questions 12 – 14 below.

12.(3 points) The profit maximizing output is .

13.(3 points) The profit maximizing level of labor input is workers.

14.(3 points) The maximum profit for this firm is .

15.(2 points) Using Scenario C/Table C, go to Graph 1. Label the profit maximizing Q and L combination as point C.

16.(3 points) Using Scenario C/Table C, go to Graph 4 and draw in this firm’s new wage line. The MRP curve is unchanged since MRP = P* MPL, and neither P nor MPL has changed. Shade in the new area for profit. Also label the profit maximizing point as letter C.

17.(3 points) Using Scenario C/Table C, go to graph 3 and add this firm’s new supply curve (remember that wages fell, so output supply increases). Label as point C the price and output combination occurring after the change in economic conditions in Scenario C (P= $20, and the profit maximizing Q you found in your answer for #12 above). You only have one point on this supply curve, but you can sketch it as an upward sloping supply curve that is parallel to the supply curve you drew earlier.

18.(2 points) When comparing Scenario A to Scenario C, the firm now hires _______

A) more

B) fewer

19.(2 points) When comparing Scenario A to Scenario C, the firm now produces _____

A) more

B) less

20.(2 points) When comparing Scenario A to Scenario C, the firm now earns _______ profit.

A) more

B) less

SCENARIO D – In this final scenario, we again return to our original conditions (from scenario A) and consider a positive productivity shock, just like we did in the lectures. In particular, let the MPL of each worker rise by two, due to an increase in total factor productivity (denoted A in the lecture), relative to the initial conditions.

For question 21, fill in Table D. Each box is worth ½ point for a total of 15 points for Table D

TABLE D- The wage is $150 and the price of output (Q) is $20.

21.

L Q MPL MRP Marginal Profit Total Profit

0 0 —– —– ———– 0

1

$

$

$ 2

$

$

$ 3

$

$

$ 4

$

$

$ 5

$

$

$ 6

$

$

$

Use Scenario D/Table D to answer the questions 22 – 24 below.

22.(3 points) The profit maximizing output is .

23.(3 points) The profit maximizing level of labor input is workers.

24.(3 points) The maximum profit for this firm is .

25.(3 points) Using Scenario D/Table D, go to Graph 1. Draw your new production function (remember technology [total factor productivity] increased, shifting the production function!) Label the new profit maximizing Q and L combination as point D.

26.(3 points) Using Scenario D/Table D, go to Graph 5 and draw this firm’s new MRP curve (remember that MRP = P* MPL, and since MPL has changed, we know we have a new MRP curve!). Shade in the new area of profit. Also label the new profit maximizing point as letter D.

27.(3 points) Using Scenario D/Table D, go to Graph 3 and add this firm’s new supply curve (a positive productivity shock increases supply!). Label the price and output combination after the change in economic conditions in Scenario D (P= $20, and the profit maximizing Q you found in your answer for #22 above). You only have one point on this supply curve, but you can sketch it as an upward sloping supply curve that is parallel to the supply curves you drew earlier.

28.(2 points) When comparing Scenario A to Scenario D, the firm now hires _______ workers.

A) more

B) fewer

29.(2 points) When comparing Scenario A to Scenario D, the firm now produces _____ output.

A) more

B) less

30.(2 points) When comparing Scenario A to Scenario D, the firm now earns _______ profit.

A) more

B) less

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