Scenario # 1: (25 points total). Suppose that due to favorable economic conditions, the price that this firm can sell its…

1. Scenario # 1: (25 points total).

   Suppose that due to favorable economic conditions, the price that this firm can sell its product for rises to $22. Fill in the following table. Solve for the new profit  maximizing output and profit (5 points).

TABLE 2

The current wage is $150 and the price of output (Q) = $22.

a.       (5 points for i through iii) 

                                                               i.      The profit maximizing output is _______.

                                                             ii.      The profit maximizing level of labor input is ________ workers.

                                                            iii.      The maximum profit for this firm is  __________.

b.       Locate this change in conditions as point B on the production function you drew in part 1b above.

c.       (10 points for correct and completely labeled diagram with points A, B, C, and D) Now construct a supply curve as we did in lecture with point A representing the original price – output combination and point B representing the price – output combination after the change in economic conditions (after price rises to $22).[2]  Make sure you label the graph completely including what we hold constant along the supply curve. Note, you will be adding points C and D to this diagram.

Given the change in prices, identify point B on your W / MRP labor market diagram that you drew in part 1c.  Be sure to completely label your diagram as we do in the lectures.

d.       (5 points) Explain exactly why the firm changes their behavior (hint, it might help to consider what the difference would be if they did not change their behavior).

1. Scenario # 2 (20 points total)

   We return to the original conditions and now we let wages change.  In particular, let an increase in labor supply lowers the wage that the firm needs to pay to $130.  Fill in the table below (5 points).

TABLE 3

The current wage is $130 and the price of output (Q) = $20.

a.       (5 points for i though iii) 

                                                               i.      The profit maximizing output is _______.

                                                             ii.      The profit maximizing level of labor input is ________ workers.

                                                            iii.      The maximum profit for this firm is  __________.

b.       Locate this change in conditions as point C on the production function you drew in part 2b above.

c.       (5 points) Explain exactly why the firm changes their behavior (hint, it might help to consider what the difference would be if they did not change their behavior).

d.       (5 points) Re – draw the W / MRP labor market diagram depicting initial conditions (i.e., point A) and now add the new conditions given the lower wage as point C.

Now add point C to your supply curve diagram (don’t draw a new diagram) that you drew in part 2b),  being sure to label diagram completely.

4.      Scenario # 3: (30 points total)

In this final scenario, we return to our original conditions and consider a positive productivity shock, just like we did in the lectures.  In particular, let the MP_L of each worker rise by two, due to  an increase in total factor productivity (denoted A), relative to the initial conditions. Fill in the following table (5 points) and answer the following questions.

TABLE 4

The current wage is $150 and the price of output (Q) = $20.

a.       (5 points i through iii)

                                                   i.      The profit maximizing output is _______.

                                                 ii.      The profit maximizing level of labor input is ________ workers.

                                                iii.      The maximum profit for this firm is  __________.

b.       Locate this change in conditions as point D on the production function diagram you drew in part 1b).

c.       (5 points) Explain exactly why the firm changes their behavior (hint, it might help to consider what the difference would be in terms of profit if they did not change their behavior).

d.       (5 points) Re – draw the W / MRP labor market diagram depicting initial conditions (i.e., point A) and now add the new conditions given the increase in productivity as point D.

Now add point D to your supply curve diagram (don’t draw a new diagram) that your drew in part 1b),  being sure to label diagram completely.

e.       (10 points)  Suppose the workers bargain for and get a raise so that nominal wages rise to $170.  Re-calculate the maximum profits that this firm can achieve given he increase in productivity and nominal wages and compare to the original profits.  Also compare the level of labor, real wages, and output given these two changes relative to the original conditions.  Are these results consistent with the New Economy, why or why not?