Micro Review

Utility, Wages, and Externalities

TP and AP

• Total Product (TP)- the total output of a particular good or service produced

• Average Product (AP)- the total output produced per unit of a resource employed

• AP = total product divided by quantity of resource employed

Marginal Product (MP)

• Additional output resulting from using each additional unit of labor

• Law of diminishing returns applies to marginal product---at some point the MP will decrease

Marginal Revenue Product (MRP)

• The change in a firm’s total revenue when it employs 1 additional unit of a resource

• MRP = change in total revenue/change in the quantity of the resource employed

Marginal Resource Cost (MRC) aka Marginal Factor Cost (MFC)

• The amount that each additional unit of a resource adds to the firm’s total (resource) cost

• MRC = change in total (resource) cost/unit change in resource quantity

MRP=MRC Rule

• To maximize profit a firm should employ the quantity of a resource at which MRP=MRC

• To maximize profit, a firm should hire any additional units of a specific resource as long as each successive unit adds more to the firm’s TR than it adds to cost TC

Labor Market Equilibrium

• The intersection of the market labor demand curve and the market supply curve determines the equilibrium wage rate and level of employment

($10)WC

Quantity of Labor

QC(1000)

0

D=MRP(∑ mrps)

S

Individual Firm

• The individual firm in a perfectly competitive firm maximizes profit by hiring workers to the point where Wage rate = MRP

Wag

e Ra

te (D

olla

rs)

($10)WC

Quantity of Labor

0

d=mrp

qC(5)

s=MRC

c

Derived Demand

• Demand that is derived from the products that the resource helps produce

• Resources don’t usually go directly to satisfy the consumer---indirectly through their use in goods and services

• EX- land, tractor, farmer lead to demand for food

Law of Diminishing Marginal Utility

• Added satisfaction declines as a consumer acquires additional units of a given product

• The more the consumer obtains the less they want more of it

• Ex- cars (excluding collectors)

Optimal Level for Utility

• MU of product A/Price of A = MU of B/Price B• If this equation is not true, then the consumer

should reallocate their funds differently

Utility-Maximizing Combination of Products A and B Obtainable with an Income of $10

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

FirstSecondThirdFourthFifthSixthSeventh

10876543

2420181612

64

10876543

1210

98632

Compare Marginal UtilitiesThen Compare Per Dollar - MU/PriceChoose the HighestCheck Budget - Proceed to Next Item

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

FirstSecondThirdFourthFifthSixthSeventh

10876543

2420181612

64

10876543

1210

98632

Again, Compare Per Dollar - MU/PriceChoose the HighestBuy One of Each – Budget Has $5 LeftProceed to Next Item

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

FirstSecondThirdFourthFifthSixthSeventh

10876543

2420181612

64

10876543

1210

98632

Again, Compare Per Dollar - MU/PriceBuy One More B – Budget Has $3 LeftProceed to Next Item

(1)Unit ofProduct

(a)MarginalUtility,

Utils

(a)MarginalUtility,

Utils

(b)Marginal

UtilityPer Dollar

(MU/Price)

(b)Marginal

UtilityPer Dollar

(MU/Price)

(2)Product A:Price = $1

(3)Product B:Price = $2

FirstSecondThirdFourthFifthSixthSeventh

10876543

2420181612

64

10876543

1210

98632

Again, Compare Per Dollar - MU/PriceBuy One of Each – Budget Exhausted

Monopsony

A single employer of labor has substantial buying (hiring power) with the following characteristics:

1. Only a single buyer of a particular good2. Labor is immobile (workers would have to

move or acquire new skills)3. The firm is a wage maker**monopsony power can vary

Monopsony Model

Wag

e R

ate

(Do

llars

)

Quantity of Labor

0

S

MRP

MRC

c

b

aWc

Wm

Qm Qc

Examples of Monopsony Power

Monopsonistic Labor Market

W 14.1

Positive Externalities

P S

D private

D Social

Quantity

P

Q mkt Q Social

Spillover BenefitSubsidy

The government can correct this externality by subsidizing the producer or the consumer (vouchers)

Negative Externalities

P

Pmkt

Quantity

D

S SocialS private

Spillover Costs = Pollution Tax