consumer behavior representative consumer rationale two goods consumption bundles

Consumer Behavior

Representative Consumer

bull 1048698 Rationale

bull 1048698 Two goods

bull 1048698 Consumption bundles


bull Preferences

bull Three properties of preferences

1More is preferred to less

2Likes diversity

3C and L are normal goods

Preferences Utility function andIndifference Curves

bull 1048698 Utility function

bull 1048698 What is an indifference curve

bull 1048698 Properties of indifference curves (derived from properties of preferences)

MRS(lC) Marginal Rate ofSubstitution of l for C

bull MRS(lC) amount of C we would give up to get one additional unit of l (at the margin)

bull Equal to (-1) times the slope of the indifference curve

bull Properties

Consumer Choice

bull Consumerrsquos ldquoproblemrdquo is to choose the best consumption bundle subject to constraints

ndash Time constraint

ndash Budget constraint

Budget Set (T lt π case)

Consumer Optimization

Income (or ldquoWealthrdquo) Effects

bull ldquoWhat happens when non-wage income changesrdquo

bull Change in non-wage income induces a ldquopure

income (wealth) effectrdquobull Recall ldquoboth goods are normalrdquo assumptio

nhellip So what is the net effect of Δ(π ndash T ) gt 0

Increase in the real wage rateIncome and substitution effects

bull Key w is1 wage earned on labor hours but also2 Price of leisure relative to consumptionbull Increase in w increases (wh + π ndash T)bull Then both goods normal sohellipbull But w increases price of l relative to C sohellipbull Conclusion Consumption must rise but leisure

may rise or fall


Labor Supply Curve

bull 1048698 Ns(w) = h ndash l(w)

bull 1048698 What is the effect of an increase in non-wage income (dividends or lump-sum taxes)

Production of Goods

bull What are goods good forbull ldquoTechnologyrdquo the Production FunctionY = zF( K Nd )ndash K and Nd are inputs or ldquofactors of producti

onrdquondash z is total factor productivitybull K is determined by past investmentbull Nd may be varied in the short run

Marginal Products MPN

bull Marginal product of labor (MPN) is the amount of additional output produced by adding an additional unit of Nd (holding K fixed)

Marginal Products MPK

bull Marginal product of capital (MPK) is the amount of additional output produced by adding an additional unit of K (holding Nd fixed)

Cobb-Douglas Production Fn

bull 1048698 Y = zKa (Nd)b

Assumptions about the productionfunction

bull 1 Constant returns to scale (CRS)Increasing production fnbull 2 uarrK or uarrNd causes uarrYEquivalent statement MPNgt0 MPKgt0

Diminishing marginal productsbull 3 MPN decreases as N increasesbull 4 MPK decreases as K increasesComplementarities in productionbull 5 MPN increases as K increases(and MPK increases as N increases)

bull Complementarities in prodrsquon

bull 5 MPN increases as K increases

(and MPK increases as N increases)

Figure 417 Adding Capital Increases the Marginal Product

of Labor

Whatrsquos z

bull 1048698 Total factor productivity represents level of

technology or efficiency in prodrsquon

Examples of z changes

ndash technological advance discovery of new techniquesetc

ndash Random economic shocks (weather)

ndash Inefficiency induced by govrsquot regulation

ndash Energy price shocks

Figure 418 Total Factor Productivity Increases

Figure 419 Effect of an Increase in Total Factor Productivity on the Marginal Product of Labor

The Objective of the Firm ishellip

MAXIMIZE PROFIT

Profit is

ndash Revenue minus costs

bull π = Y ndash wNd= zF( K Nd ) ndash wNd

Cobb-Douglas Production fn andthe Solow Residual

bull Y = zKa (Nd)bbull ndash Exhibits CRS if b = 1 ndash abull Theory says that share of Y paid to labor should

be 1-a 1 ndash a = wN Ybull Looking at data set 1 ndash a = 64 (a = 36)bull The ldquoSolow residualrdquo is measure of TFP (z)obtained this waybull z = Y ( K36 (Nd)64 )

Figure 420 The Solow Residual for the United States

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bull Preferences

bull Three properties of preferences

1More is preferred to less

2Likes diversity

3C and L are normal goods








bull Properties

Consumer Choice













may rise or fall


Labor Supply Curve



Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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bull Properties

Consumer Choice













may rise or fall


Labor Supply Curve



Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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Consumer Choice













may rise or fall


Labor Supply Curve



Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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may rise or fall


Labor Supply Curve



Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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Labor Supply Curve



Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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Production of Goods
















of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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of Labor

Whatrsquos z











MAXIMIZE PROFIT

Profit is







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Whatrsquos z











MAXIMIZE PROFIT

Profit is







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MAXIMIZE PROFIT

Profit is







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consumer behavior representative consumer rationale two goods consumption bundles

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