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CHAPTER 31 PRODUCTION

CHAPTER 31 PRODUCTION. The Robinson Crusoe Economy. One consumer and one firm; The consumer owns the firm; Preference: over leisure and coconuts; Technology: use leisure to produce coconuts; The planner’s problem: F.O.C. The Robinson Crusoe economy. The Competitive equilibrium.

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CHAPTER 31 PRODUCTION

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  1. CHAPTER 31PRODUCTION

  2. The Robinson Crusoe Economy • One consumer and one firm; • The consumer owns the firm; • Preference: over leisure and coconuts; • Technology: use leisure to produce coconuts; • The planner’s problem: • F.O.C.

  3. The Robinson Crusoe economy

  4. The Competitive equilibrium • Labor market and goods market; • The consumer supplies labor and buys consumption goods from markets; • The firm hires labor and sells output in markets; • Utility maximization and profit maximization; • General equilibrium on both markets; • The consumer is the shareholder of the firm.

  5. The Competitive equilibrium • The firm’s behavior: • F.O.C. • The firm’s profits:

  6. The Competitive equilibrium • The firm’s behavior

  7. The Competitive equilibrium • The consumer’s budget constraint: • The consumer’s problem: • F.O.C.

  8. The Competitive equilibrium • The consumer’s behavior

  9. The Competitive equilibrium • The competitive outcome is Pareto efficient.

  10. The Competitive equilibrium

  11. Different Technologies • Constant returns to scale • Zero profits for the firm; • The isoprofit coincides with the production function; • The budget line coincides with the isoprofit; • The competitive equilibrium is Pareto efficient.

  12. Different Technologies • The competitive equilibrium exists.

  13. Different Technologies • Increasing returns to scale • The Pareto efficient allocation cannot be achieved by the competitive market. • The firm would be making negative profits at the Pareto efficient allocation; • Given any market price, the profit-maximization problem has no solution.

  14. Different Technologies • The Pareto efficient allocation is not attainable.

  15. The 1st and 2nd theorem of welfare economics • Assuming convexity and closedness, the competitive equilibrium exists; • The competitive equilibrium is Pareto efficient; • Assuming convexity, any Pareto efficient allocation can be achieved by a competitive equilibrium.

  16. Production possibilities • One input, multiple output; • Production possibility set: set of feasible outputs; • Production possibility frontier: set of efficient outputs; • Marginal rate of transformation: the rate at which the economy substitutes one output for another.

  17. Production possibilities

  18. Comparative Advantage • Robinson Crusoe: FC/10+CC/2010; • Friday: FF/20+CF/1010; • Robinson has a comparative advantage in coconuts and Friday has a comparative advantage in fish.

  19. Comparative Advantage

  20. Comparative Advantage • Joint production possibility set:

  21. Comparative Advantage

  22. Pareto efficiency • Given total output (x1, x2), the competitive equilibrium is given by MRSA=MRSB. • We must have MRSA=MRSB=MRT; • The slope of indifference curves at the competitive equilibrium must equal the slope of the PPF at (x1, x2).

  23. Pareto efficiency

  24. Competitive Equilibrium • Assuming inelastic supply of labor: LC+LF=L; • The firm’s problem: • F.O.C.

  25. Competitive Equilibrium • The firm chooses a point on the PPF that maximizes its profits given prices.

  26. Competitive Equilibrium • The consumer’s problem: • F.O.C.

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