Economics 11
Caltech Spring 2010
Problem Set 4
Homework Policy: Study You can study the homework on your own or with a group of fellow students. You should feel free to consult notes, text books and so forth.
The quiz will be available Wednesday at 5pm. Following the Honor code, you should find 20 minutes and do the quiz, by yourself and without using any notes. Paper and pen should be all you need. Then turn it in by Thursday 5pm. (drop off in box in front of Baxter 133). It will include one question from each section
The answers to the whole homework will be available Friday at 2pm.
Definitions Please explain each term in three lines or less!
• Shadow value The shadow value of capital refers to the value associated with a constraint, i.e. when capital cannot be adjusted in the short‐run it creates a constraint on the profit. • Marginal product The additional output that can be produced by one more unit of a particular input while holding all other inputs constant. It is usually assumed that an input’s marginal productivity diminishes as additional units of the input are put into use while holding other inputs fixed. If , , • Marginal cost The cost of producing an additional unit of output. • Short‐run marginal cost The cost of producing an additional unit of output without changing anything you cannot change quickly (such as building new factories).
In the short run, some inputs (e.g., capital) are fixed, i.e., cannot be adjusted to change output levels. In such case (e.g., assuming that capital is not adjustable in the short run), the marginal cost given the amount of capital used is the derivative of the total costs with respect to the quantity of output. In other words, | , , • Short‐run average cost of production The short‐run average cost is the short run total cost of production divided by quantity, where one factor of production is fixed.
It is just the short‐run total cost of productions (i.e., holding K fixed) divided by the output, i.e., | the average of the total cost in the short run per unit of output:
• Revealed preference The preference of consumers can be revealed by their purchasing habits. • Fixed costs Costs that do not change as the level of output changes in the short run. Fixed costs are in many respects irrelevant to the theory of short run price determination. • Total Factor Productivity A variable which accounts for effects in total output not caused by inputs. For example, a year with unusually good weather will tend to have higher output, because bad weather hinders agricultural product. A variable like weather does not directly relate to unit inputs, so weather is considered a total‐factor productivity variable (Wiki).
Word problems Please explain each question in a few sentences.
• Consider fixed capital, what are the implications of the first order condition of the profit maximization problem? What does the second order condition imply? Given a fixed level of capital K, the firm chooses L to maximize profit. From the firm’s (short‐run) profits , , we obtain the first order condition: