Integrating the Output and Substitution Effects of Production into the Intermediate Microeconomics Textbook
Business Education & Accreditation, v. 5 (1) p. 81-90
10 Pages Posted: 29 Jan 2013
Date Written: 2013
Intermediate microeconomics textbooks employ indifference curve analysis to explain the income and substitution effects of a change in the price of a good x on the demand for it, holding other variables constant. Further, they demonstrate how the shape and slope of the demand curve changes depending on whether good x is defined as normal, inferior, or Giffen. This analysis in turn enables an evaluation of public policies aimed to increase consumer welfare. Unfortunately, these textbooks do not apply a parallel analysis in production theory, creating an analytical vacuum at the undergraduate level. This paper develops a model to analyze the output and substitution effects in production when the price of one input (labor) changes, holding technology, resource availability, and the price of the other input constant. This study will also address the production equivalents of normal, inferior, and possibly Giffen inputs affecting the shape and slope of the input demand curve. Such an exercise may allow students to gain a better understanding of producer and consumer theories, and encourage them to employ these concepts to real economic problems such as the effect of wage subsidies on labor demand. It should therefore be included in intermediate microeconomics textbooks.
Keywords: Substitution Effect, Output Effect, Isoquants, Consumer Theory, Producer Theory
JEL Classification: A22, D11, D24
Suggested Citation: Suggested Citation