Economics II_Session-3 _Production.ppt

ECONOMICS II :?MARKETS AND HIERARCHIES“ Microeconomics ?2008 Efficient production Efficient production Efficient production E.g.: The wage price of labour increases The effect of a price increase for labour: The substitution effect The effect of a price increase for labour: The substitution effect Expansion Path Labour Capital q2 medium size swimming pool L1* K1* L2* K2* Production – How to produce TC1 TC2 q1 small size swimming pool Change of Factor Prices– The Output Effect 2nd case: Think that after an increase in price of labour you don‘t want to spend more money for your swimming pool but instead you accept a smaller swimming pool. An increase of the price of labour induces a rotation of the isocost line ?old“ isocost line TC1 becomes ?new“ one TC2 because the ratio of prices for labour and capital has changed. if your budget remains unchanged than you can‘t pay all of the costs of building the medium sized swimming pool TC2 is not tangent to Isoquant q2 . Instead you can only produce output q1 i.e. the small sized swimming pool . Production – How to produce Change of Factor Prices– The Output Effect Again: Because of the increase of wage the slope of TC3 is more flatten than the slope of TC1 reflecting the change on relative prices the firm has to adjust the ratio of marginal products in order to produce efficiently. Here: The firm has to substitute labour by capital. however, the firm will employ less additional capital as in the 1st case when you decided to increase your budget ?Output Effect“ . The reason for this is that you reduced output. It is even possible that the output effect outweights the substitution effect, as can be seen below. Then, the increase in the price of labour results in less employment of labour and less employment of capital. Capital L1* K1* L2* TC1 TC2 q2 q1 K2* Labour * Lecturer: Dr. Hartmut Wolf Affiliation: The Kiel Institute for the World Economy phone: 0431 8814 403 e-mail: hartmut.wolf@