AP Economics: Factor Market FRQs Factor Markets FRQ January 7, 2014

1. GW Company produces and sells hats in a perfectly competitive market at a price of $2 per hat. Assume that labor is the only variable input and the wage rate is $15 per unit of labor per day. The table below shows GW's short-run production function for hats. Number of workers per day Output of hats Per day TR MRP MPP

0 0 -

1 10 20 20 10

2 26 52 32 16

3 36 72 20 10

4 44 88 16 8

5 49 98 10 5

6 52 104 6 3

(a) After which worker do diminishing marginal returns begin? After the second worker (b) Calculate the marginal physical product of the fifth worker. 5 (c) Calculate the marginal revenue product of the third worker. 20 (d) How many workers will GW hire to maximize profit? 4 (MRP>MFC of 15) (e) If GW Company has fixed costs equal to $20, what will be the company's short-run economic profits from hiring two workers? 2 52-(2*15)-20=2 (f) If the price of hats increases, what will happen to the number of workers hired in the short run? Explain. It will increase. P increases, MRP increases (shifts right) and intersects upward sloping MFC curve at higher QL

2. Assume that HZRad Company produces clock radios as shown in the short-run production function in the table below. HZRad can sell all the clock radios it produces at a market price of $20 each and can hire all the unskilled labor it needs at a wage of $90 per day per worker. Assume also that labor is the only variable input. Number of Unskilled Workers Hired 0 1 2 3 4 5 6 7 Quantity of Radios Produced (per day) 0 20 45 60 70 75 79 80 MPP MRP MFC

20 25 15 10 5 4 1

400 500 300 200 100 80 20

90 90 90 90 90 90 90

(a) Using the specific information above, draw a correctly labeled graph of HZRad's current supply curve for unskilled labor.

Axes labeled W or Wage and Q Supply Curve is horizontal line at 90

(b) What is HZRad's profit-maximizing output level? Explain. 75. Highest level where MRP>MFC (or MRP>MRC) (c) Suppose that HZRad is the first company to use a new technology that increases the productivity of its unskilled workers. (i) How will the new technology affect the quantity of unskilled labor

HZRad hires? Explain. Quantity hired increases. Increase in MPP causes increase in MRP (shift to right), which then intersects horizontal supply curve at higher Q. (ii) How will the new technology affect the wage paid to HZRad's unskilled workers? No effect.

3. Pride Textiles produces and sells towels in a perfectly competitive market. Pride Textiles hires its workers in a perfectly competitive labor market. Assume that the market wage rate for workers is $80 per day. (a) State the conditions necessary for hiring the profit-maximizing amount of labor. MRP = MFC (b) At the profit-maximizing level of output, suppose that the marginal product of the last worker hired is 20 towels per day. Calculate the price of a towel. Price = $4. $80 MFC so MRP = $80. $80 MRP / 20 towel MPP = $4 price (c) Draw a correctly labeled graph of the labor supply and demand curves for Pride Textiles, and show the equilibrium amount of labor hired.

Correct labels: Q on x axis and and W or Wage on Y axis Downward sloping MRP curve Horizontal supply curve at 80 Identify and label equilibrium amount of labor

(d) Given your answer to part (b), if the price of a towel increases, explain how Pride's profit-maximizing quantity of labor will be affected. It increases. If P increases, MRP increases and intersects the rising supply (MFC) curve at a higher Qor MRP increase, and if MRP>W, hiring increases

4. The John Lamb Company, a profit-maximizing firm producing widgets, is in a perfectly competitive widget market. Assume John Lamb employs a fixed number of employees and rents a machine for a variable number of hours from a perfectly competitive market. (a) Using correctly labeled side-by-side graphs of the factor market for machines and the John Lamb Company, show each of the following. (i) The equilibrium rental price of machines in the factor market, labeled as PR (ii) John Lambs equilibrium rental quantity of machines, labeled as QL

(i) Correct labels: X axis Quantity and Y axis Rental, PR, Q, D and S PR and Q at intersection of D, S (ii) Supply curve is horizontal line at P Demand curve is MRPM Equilibrium QL is at intersection of MRPM and SM (b) Assume that the popularity of widgets declines, decreasing the demand or widgets. What will happen to each of the following? (i) Marginal product curve for machine-hours no effect (ii) Marginal revenue product curve for machine-hours. Explain. Decreases (shifts to left). Demand for machine-hours is derived from demand for product. If demand decreases, price for widgets decreases, and if price decreases, MRP decreases. (c) John Lamb is employing the cost-minimizing combination of inputs. The marginal product of labor is 28 widgets per worker hour and the wage rate is $14 per hour. The marginal product of the machine is 60 widgets per machine-hour. What is the hourly rental price of a machine? $30. MPPL = 28 / 14 = 2 ; MPPM must also equal 2. 60/30 = 2

5. Number of Workers 1 2 3 4 5 6 Marginal Revenue Product per Day $450 $500 $450 $400 $300 $100

The table above gives the short-run marginal revenue product of labor per day for a perfectly competitive firm. The firm is currently selling its product at the market price of $5. (a) Calculate the marginal (physical) product of the third worker. 90; 450 = 90 * 5 (RP = MPP * P) (b) Define the law of diminishing marginal returns and explain why it occurs. The MPP of a variable input decreases as use of the input increasesor, as more of a variable input is used, output increases at a decreasing rate. This occurs because of overuse of a fixed input (c) Diminishing marginal returns first occur with the hiring of which worker for the firm? Third worker (d) What is the highest daily wage that the firm is willing to pay to hire the fifth worker? 300 (e) What will happen to the demand for labor if the market price of the product increases? Explain. Increases. If P increases, MRP increases (shifts to the right).

6. Assume that the market for avocados is perfectly competitive. The typical firm is earning positive economic profit in the short-run equilibrium. (a) Draw a correctly labeled graph for the typical firm, illustrating the short-run equilibrium and labeling the equilibrium market price and output PE and QE, respectively.

Correct labels: X axis is Quantity, Y axis is Price, PE and QE PE is horizontal line also labeled MR = D Correctly drawn and labeled MC and ATC curves, with MC crossing ATC at its minimum QE is where MC intersects MR
(b)

Assume there is an increase in the market wage rate for labor, a variable input. Show on your graph in part (a) the effect of the wage increase on the marginal cost curve in the short run. Correctly drawn MC and higher MC1

(c) Assume that avocado producers hire workers from a perfectly competitive labor market. Draw a graph of labor supply and demand for the typical firm and label the supply curve MFC and the demand curve MRP. Assume the market wage rate increases from w1 to w2. Show the effect of the wage increase on the graph, labeling the initial quantity of labor hired QL 1 and the new quantity of labor hired QL2.

Correctly labeled X Axis Quantity of Labor and Y Axis Wage Correctly labeled MRP is downward sloping Initial supply curve is horizontal line at W1 labeled MFC1 New supply curve is horizontal line at W2 labeled MFC2 Initial quantity of labor is at intersection of MFC1 and MRP and is labeled QL1 New quantity of labor is at intersection of MFC2 and MRP and is labeled QL2 QL2 should be less than QL1

7.

Woodland is a small town in which everyone works for TreeMart, the local lumber company. TreeMart is a monopsonist in the labor market and a perfect competitor in the lumber market. In the short run, labor is the only variable input. The labor market for TreeMart is given in the graph above. (a) Identify the profit-maximizing quantity of labor for TreeMart. 100 (b) Identify the wage rate TreeMart pays to hire the profit-maximizing quantity of labor. 10 (c) Identify the quantity of labor hired in each of the following situations. (i) TreeMart operates in a competitive labor market. 200 (ii) The government imposes a minimum wage of $12.5. Explain. 250. Minimum wage creates horizontal supply curve at 12.5, which intersects MRP (demand curve) where Q = 250.