ajaz_eco_204_2012_2013_chapter_11_producer_theory_basics

Eco 204 s ajaz hussain do not distribute another

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Unformatted text preview: ervices company is in the short run since some costs are “fixed”. 3 ECO 204 Chapter 11: Producer Theory— the Basics (this version 2012-2013) University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. Another example: suppose a firm is in the long run and uses variable capital and labor as non-essential inputs (in the sense that output can be produced by using labor and/or capital) and where the firm can produce the same level of output by substituting labor for capital at a constant rate of substitution. Again borrowing intuition from consumer theory, this production process can be modeled by the long run “Linear” or “Perfect Substitutes” production function: { } Notice that the firm can produce positive output by using labor only ( ⏟ ), or by using both labor and capital ( ⏟ ⏟ ), or by using capital only ( ⏟ ). We will demonstrate the “constant rate of substitution” below. Another example: suppose a firm is in the long run and uses variable capital and labor as inputs as essential, complementary, inputs. Again using intuition from consumer theory, we see that this production process can be modeled by the long run “complements” production function: { } Labor and capital are essential inputs because to produce positive output the firm needs both workers and capital (i.e. ) because otherwise: { } { } On the other hand, if the firm is in the short run, then its output is: ( ⏟ ) For example, suppose a firm has a Cobb-Douglas production function with variable labor but the amount of capital fixed at the level . This short run Cobb-Douglas production function is: Both inputs are essential for production and that given that capital is fixed we see that the only way to produce more output is by hiring more labor. As another example, suppose a firm has a Cobb-Douglas production function with variable labor and materials but the amount of capital fixed at the level . This short run Cobb-Douglas production function is: Here, all inputs are essential for production and given that capital is fixed we see that the only way to produce more output is by hiring more labor and/or using more materials. From these examples it should be obvious that the production function in producer theory is the counterpart of the utility function in consumer theory. As such, it shouldn’t come as a surprise that the “usual suspects” from consumer 4 ECO 204 Chapter 11: Producer Theory— the Basics (this version 2012-2013) University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. theory – Cobb-Douglas, Linear, Complements, Quasi-Linear, etc. utility functions – have counterparts in producer theory: Cobb-Douglas, Linear, Complements, Quasi-Linear, etc. production functions. The parallels between consumer and producer theory permit a facile and intuitive development of producer theory. Let’s begin by looking at “3-D production surface plots”. For example, suppose a firm’s long run production function is: defined over {( ) } The 3-D production surface plot is: This contour shows all combinations that will produc...
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