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Capital and ProductionWeek 2: Tuesday
Capital and ProductionWeek 2: Tuesday
This material is based (loosely) on Chapter 3 of your text
This material is based (loosely) on Chapter 3 of your text
From our previous episodeFrom our previous episode
FIRM #1
CONSUMER
FIRM #2
P:Q:
P:Q:
BUYER
DBUYER
DOIL
Rise in WagesRise in Wages
LABOR
SELLER
S
FIRM #1
CONSUMER
FIRM #2
P:Q:
LABOR
P:Q:
BUYERSELLER
DSOIL
Rise in WagesRise in Wages
FIRM #1
BUYERSELLER
DS
CONSUMERP:Q:
FIRM #2
P:Q:
LABOR
P:Q:
P:Q:
OIL
Rise in WagesRise in Wages
Increase in BothIncrease in Both
Pri
ce
S
0 Quantity Demanded
When both supply and demand increase . . .
Quantities increase
Prices can go either way
Increase in BothIncrease in Both
Pri
ce
S
0 Quantity Demanded
When both supply and demand increase . . .
Prices can go either way
Quantities increase
Increase in BothIncrease in Both
Pri
ce
S
0 Quantity Demanded
When both supply and demand increase . . .
Prices can go either way
Quantities increase
Increase in BothIncrease in Both
Pri
ce
S
0 Quantity Demanded
When both supply and demand increase . . .
Prices can go either way
Quantities increase
Increase in BothIncrease in Both
Pri
ce
S
0 Quantity Demanded
When both supply and demand increase . . .
Prices can go either way
Quantities increase
Moral of the StoryMoral of the Story
• AVOID trying to analyze a problem by shifting BOTH supply and demand!
• AVOID trying to analyze a problem by shifting BOTH supply and demand!
Efficiency and Production Possibilities
Efficiency and Production Possibilities
A
Production PossibilitiesProduction Possibilities
B
lack
Sh
oe
s 50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
All resources are devoted to making black shoes
A
Production PossibilitiesProduction Possibilities
D Bla
ck S
ho
es
50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
E
B Some resources are diverted to to making brown shoes
C
Production PossibilitiesProduction Possibilities
B
lack
Sh
oe
s 50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
B
A
D
C
E
The set of combinations of black shoes and brown shoes that can be made, using all resources is the Production Possibility Frontier (PPF)
Production PossibilitiesProduction Possibilities
B
lack
Sh
oe
s 50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
Points C, D, and E are EFFICIENT since they lie on the PPF
C
D
E
Production PossibilitiesProduction Possibilities
D
C
Bla
ck S
ho
es
50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
E
Points A is NOT EFFICIENT since more black shoes can be made without giving up any brown shoes
A
Production PossibilitiesProduction Possibilities
D
C
Bla
ck S
ho
es
50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
E
Points B is NOT ATAINABLEB
A
Production PossibilitiesProduction Possibilities
B
lack
Sh
oe
s 50
40
30
20
10
0 50 40 30 20 10
Brown Shoes
The slope of the PPF is the OPPORTUNITY COST of black for brown shoes
5
5
5/5 = 1 black : 1 brown
SpecializationSpecialization
Lab Partners Without Specialization
Lab Partners Without Specialization
CNAS Student
CHASS Student
Perform the experiment
Write the Report
Total time spent
2 hrs 1 hrs
1 hrs 2 hrs
3 hrs 3 hrs
Lab Partners WITH Specialization
Lab Partners WITH Specialization
CNAS Student
CHASS Student
Perform two experiments
Write two Reports
Total time spent
Time spent per assignment
0 hrs2 hrs
2 hrs1 hrs
0hrs2 hrs
2 hrs1 hrs
2 hrs3 hrs
2 hrs3 hrs
1 hrs3 hrs
1 hrs3 hrs
Ishmael earns $150 per hour as a business consultant. Also, he can change his brake pads in 30 minutes.
Ishmael's cousin, Kareem, earns $10 per hour at a
carwash and takes 3 hours to change his cousin's brake pads.
Who has the lower opportunity cost for changing brake pads?
Ishmael earns $150 per hour as a business consultant. Also, he can change his brake pads in 30 minutes.
Ishmael's cousin, Kareem, earns $10 per hour at a
carwash and takes 3 hours to change his cousin's brake pads.
Who has the lower opportunity cost for changing brake pads?
EXAMPLEEXAMPLE
KareemIshmael
Hours of work given up
Wage
0.5 hrs 3 hrs
$150 /hr $10 /hr
Opportunity Cost $75 $30
Who has the lower opportunity cost for changing brake pads?
Who has the lower opportunity cost for changing brake pads?
EXAMPLEEXAMPLE
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
EXAMPLE 2EXAMPLE 2
Which country has a comparative advantage in the production of wine?
A. France B. Switzerland C. Neither France nor Switzerland D. Both France and Switzerland
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
EXAMPLE 2EXAMPLE 2
Which country has a comparative advantage in the production of wine?
A. France B. Switzerland C. Neither France nor Switzerland D. Both France and Switzerland
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
EXAMPLE 2EXAMPLE 2
Which country has a comparative advantage in the production of CHEESE?
A. France B. Switzerland C. Neither France nor Switzerland D. Both France and Switzerland
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
• Suppose that France and Switzerland both produce cheese and wine. France's opportunity cost of producing a bottle of wine is 1.5 pounds of cheese, while Switzerland's opportunity cost of producing a bottle of wine is 3 pounds of cheese
EXAMPLE 2EXAMPLE 2
Which country has a comparative advantage in the production of CHEESE?
A. France B. Switzerland C. Neither France nor Switzerland D. Both France and Switzerland
EXAMPLE 2EXAMPLE 2Suppose that France and Switzerland begin trading wine and cheese with each other. What can be said about the trade patterns between the two countries?
A. France will trade cheese for wine and Switzerland will trade wine for cheese.
B. France will trade wine for cheese and Switzerland will trade cheese for wine.
EXAMPLE 2EXAMPLE 2Suppose that France and Switzerland begin trading wine and cheese with each other. What can be said about the trade patterns between the two countries?
A. France will trade cheese for wine and Switzerland will trade wine for cheese.
B. France will trade wine for cheese and Switzerland will trade cheese for wine.
A PPF With SpecializationA PPF With Specialization
Th
ou
san
ds
of
Au
tom
ob
iles
per
Yea
r
C
B
500 400 300 200 100
0
100
200
300
400
500
600
700
Missiles per Year
E
4
2
F
2 missiles : 1 car
1 missile : 2 cars
CapitalCapital
• What is accumulated one period that can be used to increase production in the next.
• Traditionally understood to mean tools, etc• Now often means the money used to buy
them• Can mean “human capital” or trained
workers
• What is accumulated one period that can be used to increase production in the next.
• Traditionally understood to mean tools, etc• Now often means the money used to buy
them• Can mean “human capital” or trained
workers
A Farmer’s CostsA Farmer’s Costs
• Land rent: 1 acre=$10/year
• Wages: (what he lives on for the year) $25
• Grain: $1/ bag• One bag plants one acre• Yield is 100X
• Tools:• Hoe (can work one acre) $1• Plough (can work two acres) $53• Tractor (can work four acres) $131
• Land rent: 1 acre=$10/year
• Wages: (what he lives on for the year) $25
• Grain: $1/ bag• One bag plants one acre• Yield is 100X
• Tools:• Hoe (can work one acre) $1• Plough (can work two acres) $53• Tractor (can work four acres) $131
Farmer’s First YearFarmer’s First Year
-$25Less wage
$100Revenue: one bag planted on one acre
$12Cash to start off with
0
-$1Less cost of one hoe
-$1Less cost of one bag of grain
-$10Less rent for one acre
$75Profit remaining
Farmer’s Second YearFarmer’s Second Year
-$25Less wage
$200Revenue: two bags planted on two acres
$75Cash to start off with
-$53Less cost of one plough
-$2Less cost of two bags of grain
-$20Less rent for two acres
$175Profit remaining
Farmer’s Third YearFarmer’s Third Year
-$25Less wage
$400Revenue: four bags planted on four acres
$175Cash to start off with
-$131Less cost of one tractor
-$4Less cost of four bags of grain
-$40Less rent for four acres
$375Profit remaining
PPF Showing GrowthPPF Showing Growth
Capital Goods
(a) United States
possibilities
This year’s production
Next year’s production possibilities
Co
nsu
mp
tio
n G
oo
ds
PPF Showing GrowthPPF Showing Growth
Capital Goods
(a) United States
Next year’s production possibilities expand less . . .
If we produce mostly consumption goods
A
Co
nsu
mp
tio
n G
oo
ds
PPF Showing GrowthPPF Showing Growth
Capital Goods
(a) United States
. . .than if we produce more capital goods
A
Co
nsu
mp
tio
n G
oo
ds
Production of capital goods this year allows for increased production of BOTH capital and consumption goods next year
Revisiting Ayn RandRevisiting Ayn Rand
• http://www.colbertnation.com/the-colbert-report-videos/221335/march-11-2009/the-word---rand-illusion
• http://www.colbertnation.com/the-colbert-report-videos/221335/march-11-2009/the-word---rand-illusion
IN = 2:00IN = 3:26
How would “going Gault” prove anything?
What are they assuming about productivity?
Is this assumption always true?
How would “going Gault” prove anything?
What are they assuming about productivity?
Is this assumption always true?
EXAMPLEEXAMPLE
PPF Showing GrowthPPF Showing Growth
Capital Goods
(a) United States
. . .than if we produce more capital goods
A
Co
nsu
mp
tio
n G
oo
ds
Production of capital goods this year allows for increased production of BOTH capital and consumption goods next year
Return to Farmer’s Second Year
Return to Farmer’s Second Year
-$25Less wage
$200Revenue: two bags planted on two acres
$75Cash to start off with
-$53Less cost of one plough
-$2Less cost of two bags of grain
-$20Less rent for two acres
$175Profit remaining
one acre -$74
-$1one bag
$75
oneone $100
CapitalCapital
• Smith praises the middle class farmer for reinvesting his profits, producing growth.
• Smith criticized the wealthy landowners for consuming consuming all their income
• Smith praises the middle class farmer for reinvesting his profits, producing growth.
• Smith criticized the wealthy landowners for consuming consuming all their income
If the land owner were to sell his rented property. What determines how much he could get for it?
How might this explain why houses are more expensive in Silicon Valley than in Riverside?
How might an increase in income taxes effect the price of housing?
If the land owner were to sell his rented property. What determines how much he could get for it?
How might this explain why houses are more expensive in Silicon Valley than in Riverside?
How might an increase in income taxes effect the price of housing?
Think, Pair, ShareThink, Pair, Share
All taxes should fall on land value
(or the value of rentable property)
All taxes should fall on land value
(or the value of rentable property)
Henry GeorgeHenry George
Model of Production19th Century EnglandModel of Production19th Century England
• QUESTION TO ANSWER:– What is a “Fair” return to the landlard?– (or to any of the other
“factors of Production”)
• QUESTION TO ANSWER:– What is a “Fair” return to the landlard?– (or to any of the other
“factors of Production”)
Firm
s
Land
Labor
Capital
Product
Model of ProductionModel of Production
Production F
unction
Land (N)
Labor (L)
Capital (K)
Product (Q) Factors(inputs)
OutputTP
TP=f(N,L,K)
Total ProductTotal Product
• Total Product (TP) is the total output of goods and / or services
• Total Product (TP) is the total output of goods and / or services
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
1 11 11
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
1 11 11
2 18 9
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
1 11 11
2 18 9
3 22 7 1/3
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
1 11 11
2 18 9
3 22 7 1/3
4 24 6
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
1 11 11
2 18 9
3 22 7 1/3
4 24 6
5 25 5
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meal Price Revenue
1 11 $8
2 18 $8
3 22 $8
4 24 $8
5 25 $8
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meal Price Revenue
1 11 $8 $88
2 18 $8 $144
3 22 $8 $176
4 24 $8 $192
5 25 $8 $200
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meals per Worker
Meal Price Revenue
1 1113
1113
2 1822
911
3 2226
7 1/38 2/3
4 2429
67 1/4
5 2530
56
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meal Price Revenue
1 1113
8
2 1822
8
3 2226
8
4 2429
8
5 2530
8
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Meal Price Revenue
1 1113
8 88104
2 1822
8 144176
3 2226
8 176208
4 2429
8 192232
5 2530
8 200240
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
• Marginal Product (of labor) (MPL) is the additional output of goods and / or services per unit of additional input (Labor)
• Marginal Product (of labor) (MPL) is the additional output of goods and / or services per unit of additional input (Labor)
Total Product and Marginal Product
Total Product and Marginal Product
• Total Product (TP) is the total output of goods and / or services
• Total Product (TP) is the total output of goods and / or services
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Marginal Product of Labor
Meal Price Revenue MPL (in terms of $)
1 11 11 8 88 88
2 18 8 144
3 22 8 176
4 24 8 192
5 25 8 200
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Marginal Product of Labor
Meal Price Revenue MPL (in terms of $)
1 11 11 8 88 88
2 18 7 8 144 56
3 22 8 176
4 24 8 192
5 25 8 200
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Marginal Product of Labor
Meal Price Revenue MPL (in terms of $)
1 11 11 8 88 88
2 18 7 8 144 56
3 22 4 8 176 32
4 24 8 192
5 25 8 200
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Marginal Product of Labor
Meal Price Revenue MPL (in terms of $)
1 11 11 8 88 88
2 18 7 8 144 56
3 22 4 8 176 32
4 24 2 8 192 16
5 25 8 200
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Diminishing Returns to Labor: Craig’s Gourmet Restaurant
Workers Meals Served
Marginal Product of Labor
Meal Price Revenue MPL (in terms of $)
1 11 11 8 88 88
2 18 7 8 144 56
3 22 4 8 176 32
4 24 2 8 192 16
5 25 1 8 200 8
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10 22
4 16 10 6
5 8 10 -2
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88
2 56
3 32
4 16
5 8
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10
2 56 10
3 32 10
4 16 10
5 8 10
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10
3 32 10
4 16 10
5 8 10
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10
4 16 10
5 8 10
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10 22
4 16 10
5 8 10
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10 22
4 16 10 6
5 8 10
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10 22
4 16 10 6
5 8 10 -2
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $10/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 10 78
2 56 10 46
3 32 10 22
4 16 10 6
5 8 10 -2
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20
3 32 20
4 16 20
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20 36
3 32 20
4 16 20
5 8 20
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20 36
3 32 20 12
4 16 20
5 8 20
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20 36
3 32 20 12
4 16 20 -4
5 8 20
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20 36
3 32 20 12
4 16 20 -4
5 8 20 -14
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?
Diminishing Returns to Labor: How many workers would you
hire if Wages were $20/hr?Workers MPL (in
terms of $)Wage MPL-Wage
1 88 20 68
2 56 20 36
3 32 20 12
4 16 20 -4
5 8 20 -14
That’s all folks!That’s all folks!