Consumer preferences over different types of breakfast cereal (i) are given by:
where Qi is the amount of cereal i that is consumed and N is the number of cereal varieties available to the consumer. These preferences are homothetic, so we can treat the demand side of this economy as if there were a representative consumer. The demand of this consumer for breakfast cereal j is given by
where Pj is the price of cereal j, Q is defined above, and
You can think of Q as being like aggregate market demand (S in class) and P as being like the average price (Pavg in class). As in class, b determines how substitutable different varieties of cereal are for each other. Assume b > 1. Unlike what we did in class, we have now derived a demand curve explicitly from preferences.
Suppose that a firm that produces breakfast cereal of type j has the following production function:
Qj = Lj ! a;where Qj is the amount of breakfast cereal j produces, Lj is the total number of workers it hires, and a is the number of workers who are required before any production takes place (e.g. the CEO, accountant, etc). Therefore, Lj a is the number of production workers. This firm faces the following total cost function:
T Cj = W (Qj + a) ;
where W is the wage paid to the workers it hires. You can think of W as the marginal cost (c) and aW as the fixed cost (F) from the model in class. Note that all firms have identical production technology.
Labor marketThe wage in this economy adjusts such that the number of workers demanded by producers of breakfast cereals equals the total labor supply. The labor market clearing condition is:
Write a short analytical essay (1.5 page of 3-5 short paragraphs) based on your chosen independent work. Drawing on the academic article you read, discuss three ways in which firm heterogeneity manifests, for example three ways in which more productive firms differ from less productive firms in their activity and performance. Then describe how firm heterogeneity matters for one aggregate economic outcome, either in steady state or in response to shocks. Finally, explain how these insights from the academic article inform one or two policy-relevant issues discussed in
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