ec2 s15 w2 d1

Capital and ProductionWeek 2: Tuesday

This material is based (loosely) on Chapter 3 of your text

From our previous episodeFrom our previous episode

FIRM #1

CONSUMER

FIRM #2

DBUYER

Rise in WagesRise in Wages

SELLER

FIRM #1

CONSUMER

FIRM #2

BUYERSELLER

FIRM #1

BUYERSELLER

CONSUMERP:Q:

FIRM #2

Increase in BothIncrease in Both

0 Quantity Demanded

When both supply and demand increase . . .

Quantities increase

Prices can go either way

0 Quantity Demanded

Quantities increase

0 Quantity Demanded

Quantities increase

0 Quantity Demanded

Quantities increase

0 Quantity Demanded

Quantities increase

Moral of the StoryMoral of the Story

• AVOID trying to analyze a problem by shifting BOTH supply and demand!

Efficiency and Production Possibilities

Production PossibilitiesProduction Possibilities

0 50 40 30 20 10

Brown Shoes

All resources are devoted to making black shoes

0 50 40 30 20 10

Brown Shoes

B Some resources are diverted to to making brown shoes

0 50 40 30 20 10

Brown Shoes

The set of combinations of black shoes and brown shoes that can be made, using all resources is the Production Possibility Frontier (PPF)

0 50 40 30 20 10

Brown Shoes

Points C, D, and E are EFFICIENT since they lie on the PPF

0 50 40 30 20 10

Brown Shoes

Points A is NOT EFFICIENT since more black shoes can be made without giving up any brown shoes

0 50 40 30 20 10

Brown Shoes

Points B is NOT ATAINABLEB

0 50 40 30 20 10

Brown Shoes

The slope of the PPF is the OPPORTUNITY COST of black for brown shoes

5/5 = 1 black : 1 brown

SpecializationSpecialization

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

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

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.

EXAMPLEEXAMPLE

KareemIshmael

Hours of work given up

0.5 hrs 3 hrs

$150 /hr $10 /hr

Opportunity Cost $75 $30

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

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

EXAMPLE 2EXAMPLE 2

Which country has a comparative advantage in the production of wine?

EXAMPLE 2EXAMPLE 2

Which country has a comparative advantage in the production of CHEESE?

EXAMPLE 2EXAMPLE 2

Which country has a comparative advantage in the production of CHEESE?

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

500 400 300 200 100

Missiles per Year

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

-$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

-$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

-$131Less cost of one tractor

-$4Less cost of four bags of grain

-$40Less rent for four acres

PPF Showing GrowthPPF Showing Growth

Capital Goods

(a) United States

possibilities

This year’s production

Next year’s production possibilities

Capital Goods

(a) United States

Next year’s production possibilities expand less . . .

If we produce mostly consumption goods

Capital Goods

(a) United States

. . .than if we produce more capital goods

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

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

Capital Goods

(a) United States

. . .than if we produce more capital goods

Production of capital goods this year allows for increased production of BOTH capital and consumption goods next year

Return to Farmer’s Second Year

-$25Less wage

$200Revenue: two bags planted on two acres

-$53Less cost of one plough

-$2Less cost of two bags of grain

-$20Less rent for two acres

one acre -$74

-$1one bag

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”)

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

Diminishing Returns to Labor: Craig’s Gourmet Restaurant

Workers Meals Served

Meals per Worker

1 11 11

Meals per Worker

1 11 11

2 18 9

Meals per Worker

1 11 11

2 18 9

3 22 7 1/3

Meals per Worker

1 11 11

2 18 9

3 22 7 1/3

4 24 6

Meals per Worker

1 11 11

2 18 9

3 22 7 1/3

4 24 6

5 25 5

Meal Price Revenue

1 11 $8

2 18 $8

3 22 $8

4 24 $8

5 25 $8

Meal Price Revenue

1 11 $8 $88

2 18 $8 $144

3 22 $8 $176

4 24 $8 $192

5 25 $8 $200

Meals per Worker

Meal Price Revenue

1 1113

2 1822

3 2226

7 1/38 2/3

4 2429

67 1/4

5 2530

Meal Price Revenue

1 1113

2 1822

3 2226

4 2429

5 2530

Meal Price Revenue

1 1113

8 88104

2 1822

8 144176

3 2226

8 176208

4 2429

8 192232

5 2530

8 200240

• 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 (TP) is the total output of goods and / or services

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

1 11 11 8 88 88

2 18 7 8 144 56

3 22 8 176

4 24 8 192

5 25 8 200

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

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

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?

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

1 88 10

2 56 10

3 32 10

4 16 10

5 8 10

1 88 10 78

2 56 10

3 32 10

4 16 10

5 8 10

1 88 10 78

2 56 10 46

3 32 10

4 16 10

5 8 10

1 88 10 78

2 56 10 46

3 32 10 22

4 16 10

5 8 10

1 88 10 78

2 56 10 46

3 32 10 22

4 16 10 6

5 8 10

1 88 10 78

2 56 10 46

3 32 10 22

4 16 10 6

5 8 10 -2

1 88 10 78

2 56 10 46

3 32 10 22

4 16 10 6

5 8 10 -2

1 88 20 68

2 56 20

3 32 20

4 16 20

1 88 20 68

2 56 20 36

3 32 20

4 16 20

5 8 20

1 88 20 68

2 56 20 36

3 32 20 12

4 16 20

5 8 20

1 88 20 68

2 56 20 36

3 32 20 12

4 16 20 -4

5 8 20

1 88 20 68

2 56 20 36

3 32 20 12

4 16 20 -4

5 8 20 -14

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!

ec2 s15 w2 d1

production of wine

brown shoes points b

brown shoes points c

demand increase

bottle of wine

opportunity cost of

lower opportunity cost

switzerlands opportunity

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