This preview shows pages 1–10. Sign up to view the full content.
This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: 1 Fin 501 Financial Economics Lecture 5: Cost Functions, Profit Maximization, Supply Functions. Professor Nolan Miller 2 Announcements Sorry for the cancelation. Problem Set #2 is available on Compass, due next Thursday. Ill decide what to do about problem set #3. Copies of the texts are available on the library reserve shelf. Nicholson & Snyder Intermediate Microeconomics, Microeconomic Theory Books that may be useful references when we cover finance applications, game theory, macroeconomics. 3 Production & Supply Firms have production functions. A profit maximizing firm must minimize cost. CMP: choose inputs to min. cost of producing Q units of output. Solution to CMP is conditional factor demand function. Cost Function gives minimum cost of producing Q units of output. 4 Production & Supply More about costs Total cost, average cost, marginal cost. Graphing cost curves Profit Maximization Supply Functions Short Run vs. Long Run considerations 5 Cost Minimization Now, we turn to the question of how the firm chooses K and L to minimize cost. Let v be the price of capital, w be the wage. The cost of (L,K) is: w L + v K. Suppose the firm wants to produce Q units of output. Then it solves the Cost Minimization Problem (CMP): min w L + v K subject to: F(K,L) Q Since producing output is costly, we know that the firm will not choose to produce more than Q. 6 Isocost Curves The firm wants to minimize cost. The set of (K,L) that has cost C is given by: v K + w L = C, or K = w/v * L + C/v Isocost curves are lines with slope w/v. Lower costs are closer to the origin. K L K 1 L 1 These points have the same cost as (L 1 ,K 1 ) Cost decreases 7 Cost Minimization: Graphically Q 1 K L Can this point be optimal? Isocost line No. This point is cheaper and still produces Q 1 . But, is it optimal? Optimal point: tangency between isoquant and isocost line 8 Cost Minimization: Algebraically The costminimizing way to produce Q units of output: 1. Satisfies the production constraint: F(K * ,L * ) = Q . 1. Sets the MRTS = slope of isocost: These two conditions determine the solution. L K MP w MRTS MP v =  = 9 Interpreting the Tangency Condition The tangency condition can be rewritten as: w/MP L and v/MP K are the cost of producing a little more output using labor and capital, respectively....
View
Full
Document
 Spring '10
 Miller

Click to edit the document details