Factor Models and Structural Vector

Question: Discuss about the Factor Models and Structural Vector. Answer: Introduction: In the short run production, it is assumed that there is at least one-factor input which is fixed. In the short run, the marginal cost curve is upward sloping. However, it is not true that the marginal cost curve is upward slopping since the firms have to pay higher wage rate to the workers because of higher output. The law of diminishing returns mentions that in order to produce additional units, more labors are required. Thus, the marginal product of labor is low while marginal cost is high. In the short run, if the labor is kept on increasing, there will be diminishing marginal return (Mankiw, 2014). Moreover, labors are variable in the short run. The firms operating in the short run are constraint by fixed factors of production that leads to diminishing marginal products. In addition, each additional input will cause lesser output. Hence, if the labor cost for each unit is same while the production is less, then the cost of each unit increases (Stock Watson, 2015). Assuming acorn farmer with one acre of land. Increasing the amount of fertilizer would increase the amount of output. However, at a point the yield will decrease with the increase in fertilizer as it becomes poisonous. Units of fertilizer Total ears of corn Marginal ears of corn 1 100 100 2 250 150 3 425 175 4 550 125 5 600 50 6 525 -75 As the farmer increases from one to two units of fertilizer, total output increases from 100 to 250 ears of corn. Therefore the marginal ears of corn gained from one more unit of fertilizer is 150 (250 - 100). From two to three units of fertilizer, the total output increases from 250 to 425 ears of corn, a 175 marginal increase. At three units, the marginal output in ears of corn is 175, but when the fourth unit is added, the marginal output drops to 125. As the marginal product decreases, the marginal cost increases. It can be thus inferred that the marginal cost curve will be upward slopping since the marginal product curve will always be downward sloping. This is because the diminishing return will always occur for all the firms in short run. References Mankiw, N. G. (2014).Principles of macroeconomics. Cengage Learning. Stock, J. H., Watson, M. W. (2015). Factor models and structural vector autoregressions in macroeconomics.forthcoming Handbook of Macroeconomics, eds. John B. Taylor and Harald Uhlig.