## Presentation on theme: "FRQ Walkthrough #2 Perfectly Competitive Factor Market"— Presentation transcript

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FRQ Walkthrough #2Perfectly Competitive Factor MarketSlide2

2010 Perfectly Competitive Factor MarketSlide3

2010 Perfectly Competitive Factor Market

There is a lot of information here in the prompt. Notice that it says “perfectly competitive” market. At the same time, Lamb’s employees will not change, but that the quantity of hours from the machine will not change. This is telling you that on the market side, we’re talking about perfect competition, a simple supply and demand graph. Additionally, on the firm side, we’re talking about perfect competition, which in the factor market means a perfectly elastic supply curve, and the demand curve defined as “marginal revenue product.”Slide4

2010 Perfectly Competitive Factor Market

To set up the side by side graphs, technically, it doesn’t matter which one goes where, but traditionally, market goes first then firm. Slide5

2010 Perfectly Competitive Factor Market

For the market graph, draw a simple supply and demand graph, and then rent on the y-axis and quantity on the x-axis. Remember, this is the factor market, so your y-axis will always be rent (land, capital) or wage (labor).Slide6

2010 Perfectly Competitive Factor Market

For the firm graph, the trick is to draw the supply curve at the same level as equilibrium in the market graph. Same axes as the market graph, but the curves themselves will change. For the demand curve, label this as MRP.Slide7

2010 Perfectly Competitive Factor Market

MRP is marginal revenue product. It’s the additional revenue you get when you make just one more. In the product market, this is equivalent to MC. However, in the factor market, it’s flipped. It’s not about the additional cost to make it, it’s about how much additional revenue I get in to cover the costs.Slide8

2010 Perfectly Competitive Factor Market

S is going to be horizontal. I wrote S = MFC, but if you write one or the other, it should be clear from context to the reader. Again, in the factor market, perfect competition is flipped. S/MFC is perfectly elastic, not D. In PC, MR didn’t change because the revenue stayed the same no matter how many products were sold.Slide9

2010 Perfectly Competitive Factor Market

Here, S/MFC is going to the same because no matter how many widgets are produced, the cost to make each widget is the same.

The rest of this is correctly labelling PR and QL.Slide10

2010 Perfectly Competitive Factor Market

This first point is hard to get.

You need to figure out the relationship between the marginal product curve and the firm’s supply curve.

The second point is easier, if you get the graphs correct. That being said, students did get this point even without the graphs.Slide11

2010 Perfectly Competitive Factor Market

(i) Remember that the marginal product curve shows the relationship between marginal product given changes in variable inputs. Fixed inputs are locked in. This demonstrates the law of diminishing marginal returns. Every time I set up a set of variable inputs to a set of fixed inputs, I’m going to get less product and higher cost.Slide12

2010 Perfectly Competitive Factor Market

Thing is, my firm’s supply (in terms of how many machine hours it takes to make one additional product) is going to stay the same, no matter what happens to price. Because there’s no change in the amount of machine hours to make an additional product, no change in marginal product.Slide13

2010 Perfectly Competitive Factor Market

(ii) This one’s a little more easier. If you draw a little side graph like I did, you’ll see that MRP has to decrease. Similarly, if you reason your way through it, you’ll come to the same conclusion.Slide14

2010 Perfectly Competitive Factor Market

If the popularity of widgets decreases, then demand for widgets will also decrease. If demand for widgets decreases, then prices will decrease. If prices decrease, then the amount of marginal revenue I get when I sell an additional product will have to decrease. As such, the MRP curve has to decrease.Slide15

2010 Perfectly Competitive Factor Market

If you go through my answer, you’ll see that I stuck in the word “marginal”. I think if I’d have just left it as revenue, I would have gotten it wrong. Total revenue could increase as marginal revenue decreases (think elastic).Slide16

2010 Perfectly Competitive Factor MarketSlide17

2010 Perfectly Competitive Factor Market

Time to get your math on. This right here is why I want you to at least try. You can get at least one point on every FRQ.

MPL/w = MPK/r

28/14 = 60/r

2 = 60/r

2r = 60r/r

2r = 60

r = 60/2

r = $30Slide18

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2009B Open Market OperationsSlide21

2009B Open Market Operations

There’s quite a bit of information in this prompt. What does it tell you?Slide22

2009B Open Market Operations

RRR = 10%. This means that the money multiplier is 1/0.1 = 10.

Bank reserves decrease by $50 million (not MS). This comes out of excess reserves initially. MS will decrease.

Selling $50 million worth of government securities with the money multiplier will ultimately take $50 million x 10 = $500 million out of the

economy.

Open market operation sale means contractionary monetary policy. Interest rates will go up as MS decreases. Consumer spending will decrease as they save more money. Investment spending will decrease as it becomes more expensive to borrow money. As a result, AD will decrease. If AD decreases, inflation will decrease, but unemployment will increase.

Country Z has an inflation problem.Slide23

2009B Open Market Operations

Hi. Pretty sure we just answered this.Slide24

2009B Open Market Operations

$50 million. The money gets taken from excess reserves, not the required reserve.

$500 million. Notice that all this question is asking for is the maximum possible change in the MS. It is not asking for whether it’s a decrease or increase.Slide25

2009B Open Market Operations

Please label your axes correctly. For the Money Market graph, that’s nominal interest rate.

Open market sales cause the MS to decrease. Nominal interest rate increases.

Draw arrows and ant trails when in doubt.Slide26

2009B Open Market Operations

What graph is this ultimately asking about?Slide27

2009B Open Market Operations

If you said AD-AS graph, you win! When in doubt, draw it out. I drew a little mini-graph to get it working in my head.

If the nominal interest rate increases, then consumers will put their money back into banks to earn interest, and stop spending. Businesses won’t borrow because it costs them more to do so. As such, AD decreases. If AD decreases, APL and real GDP decreases.

“Equilibrium price level will decrease.”Slide28

2009B Open Market Operations

The first part of this is easy.

The second, depends on how you phrase it.Slide29

2009B Open Market Operations

People on fixed incomes would be better off if price levels drop. It means that their purchasing power would ultimately increase. Alternatively, you could state that it raises real income (which is the same thing as saying that their purchasing power would increase).

I wrote that people would be better off because the lower price level would allow them to buy more goods. I should get the point, but I’m a little worried that the AP readers are looking specifically for the words “purchasing power.” Probably not though.Slide30

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