Chapter 4 Consumer and Firm Behavior: The Work-Leisure Decision and Profit Maximization Chapter 4 Topics Behavior of the representative consumer Behavior of the representative firm Part 1: The Representative Consumer Maximizes utility over C, l Utility functions rankable with indifference Strictly prefer more C, l Representative Consumer Consumer?s preferences over consumption and leisure as represented by indifference curves. Consumer?s budget constraint. Consumer?s optimization problem: making his or herself as well off as possible given his or her budget constraint. How does the consumer respond to: (i) an increase in non-wage income; (ii) an increase in the market real wage rate? Representative Consumer?s Indifference Curves An indifference curve slopes downward (more is preferred to less). An indifference curve is convex (the consumer has a preference for diversity in his or her consumption bundle). Figure 4.1 Indifference Curves Figure 4.2 Properties of Indifference Curves Equation 4.1: Constraints on Utility maximization The consumer?s time constraint: The consumer?s budget constraint: Equation 4.3: Budget constraint accounting for time constraint. Figure 4.3 Representative Consumer?s Budget Constraint (T > ?) Figure 4.4 Representative Consumer?s Budget Constraint (T < ?) Consumer Optimization The consumer chooses the consumption bundle that is on his or her highest indifference curve, while satisfying his or her budget and time constraints. Figure 4.5 Consumer Optimization Equation 4.6: Holds when the consumer is optimizing The marginal rate of substitution of leisure for consumption equals the real wage. Real dividends or taxes change for the consumer Assume that consumption and leisure are both normal goods. An increase in dividends or a decrease in taxes will then cause the consumer to increase consumption and reduce the quantity of labor supplied (increase leisure). Figure 4.7 An Increase in ? ? T for the Consumer. An increase in the market real wage rate This has income and substitution effects. Substitution effect: the price of leisure rises, so the consumer substitutes from leisure to consumption. Income effect: the consumer is effectively more wealthy and, since both goods are normal, consumption increases and leisure increases. Conclusion: Consumption must rise, but leisure may rise or fall. Figure 4.8 Increase in the Real Wage Rate?Income and Substitution Effects Figure 4.11 Perfect Complements Part II: The Representative Firm The production function. Profit maximization and labor demand. Equation 4.9: The Firm?s Production Function Properties of the Firm?s Production Function Constant returns to scale. Output increases with increases in either the labor input or the capital input. The marginal product of labor decreases as the labor input increases. The marginal product of capital decreases as the capital input increases. The marginal product of labor increases as the quantity of the capital input increases. Figure 4.12 Production Function, Fixing the Quantity of Capital and Varying the Quantity of Labor Figure 4.14 Marginal Product of Labor Schedule for the Representative Firm Figure 4.15 Adding Capital Increases the Marginal Product of Labor Figure 4.16 Total Factor Productivity Increases Figure 4.17 Effect of an Increase in Total Factor Productivity on the Marginal Product of Labor Equation 4.12: Profit Maximization When the firm maximizes profits, the marginal product of labor equals the real wage. Figure 4.19 Revenue, Variable Costs, and Profit Maximization Figure 4.20 The Marginal Product of Labor Curve Is the Labor Demand Curve of the Profit-Maximizing Firm Equation 4.10: The Cobb-Douglas Production Function Coefficients on K, N sum to one Coefficients on K, N both positive Satisfies CRS, Decreasing returns Coefficients on K, N represent their share of total production costs Equation 4.10: A Specific Production Function Equation 4.11: Solow Residual Figure 4.18 The Solow Residual for the United States
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