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LEC 3

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10 views

LEC 3

Uploaded by

Nausheen Sodhi
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
You are on page 1/ 24

FIRMS

And their decisions


What we’ll learn
Firms’ production, cost
and supply functions

Optimal pricing

Do firms really
maximize profits?
What determines the
boundaries of firms?
Why do different firms
perform differently?
What about firms?
• Specific to this course, we refer to the firms’ process of transforming
inputs to outputs
• This involves selecting optimal input mix and an optimal output mix
• Comparing firms as price takers vs not
The production function
• Let’s think of examples of conversion
of inputs to outputs in the (a) goods
market (b) service sector market

Inputs • Production function ()) is the mapping


that tells us, for a given set of inputs,

and
how much output a firm can produce.
Depends on:
• Efficiency of firms
outputs • Quality of inputs (skilled vs
unskilled labor)
• Here, we’ll consider 2 inputs: labor
and capital. Does this suffice?
What does look like?
2 extreme cases
• When inputs are perfect
complements
• Used in fixed proportions (e.g. pilots &
planes- ignore co-pilots)
• More pilots in a plane doesn’t amount to
more passengers
• More pilots than planes??

• This gives us right angled isoquants

From points a, b and c – which one


seems most efficient? Why?
• When inputs are perfect
substitutes

• Suppose McDonalds uses only one


input- beef (Texan or Nebraskan
doesn’t matter-why?)

• McDonalds’ total output (burgers)


depends on the total beef (and not q=2
the proportions from Texas or q=1
Nebraska)

• This gives us straight isoquants

• One burger requires one unit of


either Texas beef and zero of
Nebraska beef and vice-versa
The intermediate
case: Cobb-Douglas

• Using values of for output levels


q=1, q=2 and q=3, the graph
depicts 3 isoquants
• Why are they downward
sloping?
• Why are they convex?
(diminishing marginal returns)
• Also, the closer complements
the inputs are, more convex the
isoquants are
Secretaries vs IT
specialists
• Secretarial services (L) and
desktop computers (K) are
largely substitute inputs
• IT specialists (L) and desktop
computers (K) are largely
complement inputs

What would be the shape of


isoquants for these two
combination of inputs?
Productivity
• One of the ways to measure- average labor productivity, that is, revenue
per worker =
• Drawback? Two firms might have the same production functions. But if
one of them has a higher level of capital, it will also have a higher level
of labor productivity!
• Better measure? Total factor productivity (TFP)
• If two firms have the same
• (a) given market price (of?)
• (b) Cobb-Douglas
• (c) same and coefficients (but different quantities of K and L)
• Then TFP () is a better measure of firm’s performance

(Eq.1)
{
Higher , higher output
• Taking logs on both sides of eq.1

Thus,
(Eq.2)
• Solving, we get:
Estimating
TFP • and

• Thus, profit maximizing firm chooses input levels


such that ratio between their input costs (wL or
rK) and total revenue (pq) is equal to the
respective coefficient Cobb-Douglas production
function ( or , resp)
• Can you solve for this?
Cost minimization
Cost functions
Pricing
Optimal pricing: Intuitive approach
Optimal pricing: Calculus approach
Elasticity
Margins and markups
Do firms maximize profits?
What determines a firm’s
boundaries?
Why are firms different?
External links
• https://mbounthavong.com/blog/tag/Cobb-Douglas+pro
duction+function

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