Firm Theory Notes

Firm Theory

Eric McDermott University of Minnesota
Department of Economics

Fall 2012

Theory of the ?rm

Activities of the ?rm: 1. Acquire factors (inputs) at prices determined on factor markets 2. Combine factors according to technical possibilities to produce make. 3. Sell output on production (output) markets at prices determined in those markets. 4. Owners keep as pro?t the di?erence between: Revenue from 3.) and cost from 1.) Objelectroconvulsive therapyive: Maximize pro?t This guides all decisions ?rms make in our model. Producers: A ?rm produces output (Q) from input factors (K,L) (capital, labor), using a production technology. A action Function: relates inputs to outputs: Q = f (K , L)

When we looked at consumers we talked of indi?erence curves which held all points which yielded the like take aim of utility for the consumer. Now we will de?ne the capital-labor combinations that yield the same output for a ?rm. Q0 -level isoquant ? All combinations of (K,L) that produce Q0 succumbn f. ? {(K , L)|f (K , L) = Q0 } Isoquants are similar to indi?erence curves but here, numbers matter for to a greater extent than order. Whereas ICs are ordinal, Isoquants are Cardinal ? Isoquants give meaningful numbers for production levels. ? This allows us to compare the e?ectiveness of production functions.

Marginal Rate of Technical Substitution (MRTS)- sacrosanct value of the slope of the isoquant.




9
8
7
6
5
A
dK



Qo-isoquant

K
4
3
2
1
0
0
1
2
3
4
L
5
6
7
8

B
dL

C

Going from A to B, we know that ?Q = 0, since A and B are on the same isoquant. A?C : C ?B: Notice that:
Q ? ?f (K ,L) ? MPK ? marginal product of capital K L regular K Q ? ?f (K ,L) ? MPL ? marginal product of labor L K constant L ?Q ?K L ?Q ?L K

constant

= e?ect of ?K on output = e?ect of ?L on output. constant

Thus the total e?ect is: (rewriting *) MPK ? ?K + MPL ? ?L = 0 =? =? =? ? MPL ? ?L = ?MPK ? ?K ?K MPL =? = neg(slope of isoquant) MPK ?L MPL(K ,...If you want to get a full essay, order it on our website: Ordercustompaper.com



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