Unformatted text preview: f the economics of modern ﬁrms. 1 ﬁnancial capital for this concept and use the term capital goods, or physical capital, for produced factors of
Here, we should be careful not to get time scales mixed up. We will usually think of inputs and outputs
as being measured in ﬂow units: a certain amount of labor per week and a certain number of machine
hours per week will produce a certain amount of output a week, for example. Then the factor prices will
be measured in units appropriate for the purchase of such ﬂows. Wages are naturally expressed in terms
of dollars per hour. The analog for machines would be the rental rate - the rate at which you can rent a
machine for the given time period.
In many cases there isn’t a very well-developed market for the rental of machines, since ﬁrms will
typically buy their capital equipment. In this case, we have to compute the implicit rental rate by seeing
how much it would cost to buy a machine at the beginning of the period and sell it at the end of the period. 3 Describing Technological Constraints Nature imposes technological constraints on ﬁrms: only certain combinations of inputs are feasible ways
to produce a given amount of output, and the ﬁrm must limit itself to technologically feasible production
plans. The easiest way to describe feasible production plans is to list them. That is, we can list all combinations of inputs and outputs that are technologically feasible. The set of all combinations of inputs and
outputs that comprise a technologically feasible way to produce is called a production set.
Suppose, for example, that we have only one input, measured by x, and one output, measured by y.
Then a production set might have the shape indicated in Figure 1. To say that some point ( x, y) is in the
production set is just to say that it is technologically possible to produce y amount of output if you have x
amount of input. The production set shows the possible technological choices facing a ﬁrm.
As long as the inputs to the ﬁrm are costly it makes sense to limit ourselves to examining the maximum
possible output for a given level of input. This is the boundary of the production set depicted in Figure
1. The function describing the boundary of this set is known as the production function. It measures the
334 TECHNOLOGY (Ch. 18)
maximum possible output that you can get from a given amount of input.
y = OUTPUT y = f (x) = production function Production set x = INPUT Figure
18.1 A production set. Here is a possible shape for a production
Figure 1: A possible shape for a production set.
set. Of course, the concept In the production function convenient equally wellproduction are several inputs. If,
of a two-input case there is a applies way to depict if there
for example, we consider the case of as the inputs, .the production function possiblex2 ) would measure the
relations known two isoquant An isoquant is the set of all f ( x1 ,
combinations of inputs 1 and that are x1 su c of...
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