# chapter_08 - 9- 1 9- 2 Learning Outcomes Profit-maximizing...

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1 9- 1 THE COST STRUCTURE OF FIRMS IN THE LONG RUN Slides by Alex Stojanovic with additions by Winston Moore 9- 2 Learning Outcomes Profit-maximizing firms use an input mix such that the ratio of marginal products of inputs equals the ratio of input prices If input prices change, methods of production will change to use fewer of those inputs that have become relatively expensive and more of those that have become relatively cheaper There is a family of short-run ATC curves, each one tangent to the long-run ATC curve The long-run cost curve can take on various shapes depending on the scale effects when all inputs are allowed to vary at once Changes in technology are often endogenous responses to changing economic signals 9- 3 Varying Combinations of Inputs • In the short run, with only one input variable, there is only one way to produce a given output: by adjusting the input of the variable factor until the optimal rate of output is achieved. • In the long run all inputs can be varied. • The firm must therefore decide both on the level of output and the best input mix to produce output. 9- 4 Varying Combinations of Inputs • In the very long run technology can change as well. 9- 5 Profit Maximisation and Cost Minimisation • In making the choice of inputs, the firm will wish to avoid being technically inefficient, using more of all inputs than necessary. • The firm will also want to be economically efficient, the one of many technically efficient options that produces a given level of output at the lowest possible cost. 9- 6 Choice of Input Mix • If it is possible to substitute one input for another in such a way that output remains constant while total cost falls, the firm is not using the least-cost combination of inputs. • If p k and p l are the prices of each unit of K and L respectively, the necessary condition for cost minimisation is L L K K p MP p MP =

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2 9- 7 Choice of Input Mix • The condition can also be written as • When the MP ratio exceeds the price ratio, the firm will substitute capital for labour. • This substitution is measured by changes in the capital-labour ratio, which is the amount of capital per worker. L K L K p p MP = 9- 8 Choice of Input Mix • The law of diminishing returns tells us that as the firm uses more capital the marginal product of capital falls, and as it uses less labour the marginal product of labour rises. • Thus as the firm adds more capital, the marginal product ratio falls. • When it reaches the same value of the price ratio, the firm does not need to substitute any further. 9- 9 The Principle of Substitution • The principle of substitution states ‘methods of production will change if the relative prices of inputs change. Relatively more of the cheaper input and relatively less of the more expensive input will be used’.
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## This note was uploaded on 11/12/2011 for the course ECON 2009 taught by Professor Mr.norvill during the Spring '11 term at University of the West Indies at Mona.

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chapter_08 - 9- 1 9- 2 Learning Outcomes Profit-maximizing...

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