Question

Consider a Robinson Crusoe economy with increasing returns to scale technology and the preference is such that coconut and leisure are perfect complements. Draw this economy on a diagram.

Answer 1

Some fundamental issues in economics can be dealt with a simple structure of Robinson Crusoe economy . The Robinson Crusoe economy is based on the assumption that there is one producer and, one consumer and two goods.Crusoe's indifference curve shows the preference of Crusoe for leisure and coconut. and the production function shows the technological relationship between his hours of work and the number of coconuts he gathered. But due to diminishing returns of labor and increasing returns to scale technology,with every additional hour of labor the additional hour of coconut he collects falls .The point at which the highest indifference curve becomes tangent to the production function is the point at which Crusoe will reach  equilibrium, between the number of hours worked by him and his relaxation hours.At this point the slope of the highest indifference curve is equal to the slope of the production function.The marginal rate of substitution is the rate at which a consumer substitutes one good for anothe keeping the same level of utility..Again marginal product is the extra output that can be produced by one more uit of input.So marginal product of labor =marginal rate of substitution between leisure and coconut