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14 views

Lecture 2

Uploaded by

030703anson
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Microeconomic Analysis & Applications

Lecture II:
Production Function & Profit
Maximization
Fall 2024
Instructor: Shi, Ce “Matthew”

The Chinese University of Hong Kong

1
Inside and Outside the Box
The way we think about firms is drastically simplistic…

• The production process as a “black box”;

• In reality, firms are much more complex; e.g.,


organization, contracts, personnel, finance.

• Again, models set good benchmarks for further


thinking.

• How should we think about firms economically?


• Textbook models
• Ronald Coase (if time permits).

Chapter One 2
Technology

Consider a single output (y) case:

Production possibilities set: Y

Input requirement set:

Isoquant:

Production function:

Chapter One 3
Cobb-Douglas technology

E.g., Cobb-Douglas w/ 2 inputs:

Chapter One 4
Some Assumptions

• (Monotonicity)

• (Convexity)
(What does it mean?)

Chapter One 5
To Notice…

• Convexity of V(y) is implied by convexity of Y.

• In other words, convexity of Y is a stronger


assumption that convexity of V(y).
(Why?)

Chapter One 6
Parametric functions
𝒙𝟐 Suppose we have two inputs…

Slope=

0
𝒙𝟏
Chapter One 7
Technical Rate of Substitution （ TRS ）

For

For a constant y,

So,

Chapter One 8
Elasticity of Substitution

Chapter One 9
Cobb-Douglas function

E.g., Cobb-Douglas

TRS?

Elasticity of substitution?

Chapter One 10
Return to Scale
• How much will output increase when we scale
ALL inputs by some amount?

Constant return to scale:

Increasing return to scale:

Decreasing return to scale:

Chapter One 11
Some Properties
• A function is homogenous of degree k if

• A function is a homothetic function iff where h


is homogenous of degree 1 and is a monotonic
function.

• If is homogenous of degree 1, then is


homogenous of degree 0. (why?)

• For both types of function, TRS is independent


of its scale of production.

Chapter One 12
CES function

E.g., CES

TRS?

Elasticity of substitution?

Chapter One 13
Elasticity of Substitution
K

=0

=1
 = 5

=
0 L
Chapter One 14
Profit Maximization: Single Input

To begin with, consider the single-input case…

The producer chooses x to maximize π(x), where


the profit function is

and : exogenous variables.

15
Profit Maximization: Single Input
The first-order condition (FOC) for profit
maximization is:

The (sufficient) second-order condition (SOC) for


maximization is ：

Interpretations?
16
Profit Maximization: Single Input

What restrictions to put on the production function?

• Constant return to scale:

• Increasing return to scale:

17
Profit Maximization: Single Input

• For given and , one can solve that equation for ;

• The optimal choice function is implicitly defined


by the FOC with

• We can use to perform comparative statics


analysis.

18
Profit Maximization: Single Input
Comparative statics:

Given

• Another observation: is homogenous of degree


zero.

19
Profit Maximization: Two Inputs
Now, consider the 2-input case…

The profit function is

FOCs:

SOC requires the Hessian matrix be negative


definite.
20
Profit Maximization: 2-Inputs

Comparative statics:

Given the FOCs and SOC,

21
Profit Maximization: 2-Inputs

Comparative statics:

Given the FOCs and SOC,


• For

• What do you find? What does the sign depend


on?

22
Profit Maximization: 2-Inputs
Comparative statics:

Given the FOCs and SOC,

• What do you find? What does the sign depend


on?

23
Profit Maximization: Two Inputs
Substituting the factor demands into y, we have

• The output supply function is homogenous of


degree 0.

• Comparative statics

24
Profit Maximization: 2-Inputs
Comparative statics:

Given the FOCs and SOC,

• What do you find? What does the sign depend


on?

25
Profit Maximization: 2-Inputs
Comparative statics:

Given the FOCs and SOC,

• What do you find? What does the sign depend


on?

26

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