ECON2302 Income and Substitution Effect Microeconomics

ECON 2302 Brookhaven College Income and Substitution Effect Microeconomics Questions

• Directions for the Problem Set

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Set 2302 Unit 4 Problem Set

1. A firm calculates that the marginal product of labor (MPL) can be found from the following equation: MPL = 35 - 2L where L is the number of workers hired.

The production function for this firm is as follows:

Q = 35L - L2 The firm knows it can find profits with the following equation: Profit = P ´ Q - W ´ L where P stands for the selling price of the good, Q stands for total output, and W represents the wage. Price is equal to $1.  

a. If the wage is $11, how many workers will the firm hire? How much profit will it earn?

b. Compare this level of profits to those earned by the firm if it hired one fewer worker than L* and one worker more than L* to demonstrate that L* workers generate the most profit for the firm.

2. Outsourcing has been a controversial topic ever since labor and manufacturing have been able to be transported. From a free-market perspective, what makes the issue so controversial?

3. Connect the idea of the real-income effect and the substitution effect with the law of demand.

4. Graphically illustrate the deadweight loss that results when a country imposes a tariff. Explain the meaning of the deadweight loss.