lecture 3

# lecture 3 - LECTURE 3 THEORY OF THE FIRM 1 Technology...

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1 LECTURE 3 THEORY OF THE FIRM

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2 Technology Definition of Technology in economics ----The set of constraints defining how one can combine or convert inputs into outputs is called a technology .
3 Technology Assumptions usually made about production technology: No free lunch: you cannot get something out of nothing; Nonreversibility: you cannot break up an output to get back the inputs; Free disposability: you can get rid of excess inputs; Additivity: activities can be combined; Divisibility: a scale down in inputs is possible; Convexity: if two combinations of inputs yield same output, then the same output can also be produced by any convex combination of these two combinations.

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4 Production Function Production Function : a function that describes the maximum amount of any output a producer in our economy can get most efficiently, given a certain level of input. Or, simply with y=output, x=inputs. ( 29 1 2 , , , n Output f input input input = L ( 29 y f x =
5 Production Function Isoquant : the combination of inputs that are required to produce a given level of outputs. Isoquants are like ICs for the utility function. Sloping down and to the right Bowed into the origin Continuous Never cross each other Farther from the origin depicting greater output Unlike ICs, they are strictly cardinal.

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6 Production Function Return to scale : measure the ratio between the resulting change in the output level and the proportionate change in the levels of all the inputs. In other word, it measures the spatial relationship between different isoquants. Constant return to scale/CRTS: proportionate changes in output is same as those in inputs; Increasing return to scale/IRTS: proportionate changes in output is greater than those in inputs; Decreasing return to scale/DRTS: proportionate changes in output is less than those in inputs.
7 Production Function Return to scale Constant return to scale/CRTS: Figure (a) in the next slide Increasing return to scale/IRTS: Figure (b) in the next slide Decreasing return to scale/DRTS: Figure (c) in the next slide For Cobb-Douglas Technology ( 29 f x y λ = ( 29 ( 29 , if >1 , if 1 f x y f x y < < ( 29 ( 29 , if >1 , if 1 f x y f x y < < 1, IRTS 1, CRTS 1, DRTS α β + + = + <

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8 Production Function Return to scale *Reasons for IRTS: specialization, scale economy, changes in physical conditions
Production Function Marginal Rate of Technology Substitution MRTS/Technical Rate of Substitution/TRS MRTS is the ratio measuring the absolute value of the slope of the isoquant at a given point, indicating the interchange rate if subtracting of one input for adding the other input while keeping original output level constant. Mathematically, MRTS of x2 for x1is

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## This note was uploaded on 01/17/2009 for the course ECON ECON 191 taught by Professor Chan during the Spring '09 term at HKUST.

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lecture 3 - LECTURE 3 THEORY OF THE FIRM 1 Technology...

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