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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 byproducts 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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 Fall '09
 Bronars

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