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Microeconomics profit function
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9 viewsLesson Four
Microeconomics profit function
Uploaded by
juniorwafula782Copyright
© © All Rights Reserved
Available Formats
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THEORY OF THE FIRM IV: THE PROFIF FUNCTION.
LECTURE FOUR.
Having discussed the firm’s technology and the costs associated, in this lesson we now turn
to the firm’s solution to its optimization problem. The solution is expressed as a profit
function. LECTURE OBJECTIVES
NN
W
At the end of this lesson, the learner should:
‘* Understand the definition and properties of the profit function
‘+ Understand how to derive the profit function THE PROFIT FUNCTION.
It represents the solution to the firm’s optimization problem. It’s expressed as a function of
output prices of input prices. ic.
x(p,w)=max[pf(x)— wx] Direct function
n(p,w) = max[p(y)-C(
Where P is the output price which the producer takes as given.
W is the vector of strictly the input prices.
¥ isa vector of inputs
» is the output
PROPERTIES OF THE PROFIT FUNCTION
(i) The profits are non-negative i.e. a producer never accepts negative profits in the long
run
(i) Its non-deei if p and p'are two output prices and that p > p'
sing in output pric
the profits evaluated: 7(p,w)2 2(p'w) ii)
(iv)
The profit function is non-increasing in input prices i.e. if w and ware two vectors
or sets of input prices and W> ’ , then #(p,w)< (pw)
‘The profit function is positively, linearly homogenous in both input and output prices.
ie. t(Ap,4w) = An(p,w) where A > 0. If output and input prices is double, then the
profits will double. This property is a further consequence of the principle that only
relative prices matter in economics.
If profit function z(p,w)is differentiable in p & w, then there exists a unique profit
maximizing supply and derived demand functions given as follows:
Supply »(p.#) (i) (First Hotellings lemma)
éx(p,w)
seit) (Second Hotellings lemma)
Demand x(p.w]
aw,
‘The Hotellings Lemma states that:
‘* If the profit function is well behaved, the first partial positive derivative of the
profit function with respect to the output prices is the firms supply funetion.
© Fora well behaved profit function (twice differentiable) the first negative partial
derivative of the profit function with respect to the input price gives the
unconditional factor demand.
(vi) The profit function is convex in all prices if and only if the production
function is strictly concave. i.e. the Hessian matrix of the profit function is,
positive semi-definite, PY\an/ Oak On, %, %, %
va Yop pw, ay Aw,
y, | a a, a ox, / ax, / ox, oi
1)» Toe Yous | Yon Yow, “Yous |?
anf anf ax, ex, ay, i
Wy éw,p /ow.w, ew? | op /dw, /ewy
_ &y which is the slope of a supply curve and is positive, and
ep
Fin Which is positive since 5 is the slope of a demand and is
negative.
“TION
x, and x,are two inputs
DERIVATION OF THE PROFIT FUN
Given a production funetion y = /(x\x;
Let P be price of output
w, & w; be prices of x,x, respectively
The firm aims at maximizing 7 given by
max m = py(x,x,)—w,x, — (Unconstrained profit maximization problem) Finding the first order conditions and equating them to zero;
Solving equations ()& (ii) simultaneously, we will find the optimal amount of inputs that
maximize profit,
(pony)
. Unconditional factor demands
x3(P.0,0)
Substituting the unconditional factor demand in the profit equation, provides the profit function
#°(po)= plyls).x3))- way — max}
where
