lect08Firm1 - 81 Theory of the Firm Firms hire inputs to...

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81 Theory of the Firm Firms hire inputs to produce output that they sell to consumers. We first consider the case of small firms who take all prices as given. The firm faces prices for its input (denoted by W’s) and for its output (denoted by P). For now, we will only consider firms who take all of these prices as given, or beyond their control. The goal of the firm is to maximize profits. It is the responsibility of the firm’s management to make as much in profits as possible for the owners or shareholders of the company. Building a loyal customer base, increasing market share, having devoted and satisfied employees may be by-products of earning profits, but the bottom line is what motivates the firms in our analysis. All firms wish to produce output at the lowest possible cost. Thus the first problem we will analyze is a firm’s cost minimization decision. We will derive a method for determining the lowest cost way to produce a given amount of output. Once the firm decides how to produce each possible amount of output, we will turn to the next part of the problem – how much output should be produced. In analyzing each of these decisions the firm chooses the option that will yield the highest profits.
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Technology Suppose there is a single input of production, X. The relationship between output, Y and the input X is given by the production function, Y=F(X). This function is an engineering relationship describing what is technologically feasible. The function F(X) can be graphed below: The MP of X = dF/dX. This is the slope of the production function and describes how much more output would be produced if one more unit of X were employed. The law of diminishing returns states that as X increases, eventually dF/dX will fall. X
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lect08Firm1 - 81 Theory of the Firm Firms hire inputs to...

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