1) The firm originally faces a wage of $150 and product price of $20. Due to higher product prices rising to $22, the firm increases output and profits. 2) With wages falling to $130, the firm further increases output and profits. 3) A productivity increase raises marginal productivity by $2. This leads the firm to increase employment and output. Higher nominal wages to $170 reduce but do not eliminate the gains from higher productivity.

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
L
Q
MP
L
MRP
Marginal Profit
Total Profit
0
0
-
-
-
0
1
8
2
20

2. 3
28
4
35
5
41
6
45
The current wage is $150 and the
price of output (Q) = $22
.
a.
(5 points for i through iii)
i.

3. 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.

4. (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).
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
L
Q
MP
L
MRP
Marginal Profit
Total Profit
0
0
-
-
-
0
1
8
2

5. 20
3
28
4
35
5
41
6
45
The
current wage is $130
and the
price of output (Q) = $20
.

6. 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),

7. 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
L
Q
MP
L
MRP
Marginal Profit
Total Profit
0
0
-
-
-
0
1

8. 2
3
4
5
6
The
current wage is $150

9. 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),

10. 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?