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ajaz_eco_204_2012_2013_chapter_11_producer_theory_basics

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University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. 1 ECO 204 Chapter 11: Producer Theory the Basics (this version 2012-2013) Department of Economics (STG), ECO 204, Sayed Ajaz Hussain _________________________________________________________________________________________________ C HAPTER 11: Producer Theory the Basics 1 Updated: 2/19/2013 Fixed typos are shaded yellow 1. Introduction With this chapter, we are transitioning from modeling “consumer choice” to modeling “producer choice”. In ECO 204, we view the producer ( firm ”, “company”) as a “black - box” entity using its technology and management to transform inputs into the output of a product/service 2 : By treating the firm as a “black box” we ar e ignoring interesting topics such as, amongst many, the firm’s structure/organization/objective and how its employees are compensated and incentivized 3 . In this chapter, we consider a firm with an exogenously given “target output level ” and model how it chooses the cost minimizing mix of inputs required to produce exactly the target level of output 4 . Formally, the cost minimization problem (CMP) is: To setup and solve the CMP, we need to discuss the firm’s inputs, production process, and input prices. We begin with by discussing the production process of how the firm transforms inputs into output. 1 Thanks: Asad Priyo, Adam Michael Lavecchi and especially Akber Nafeh for typing practice problems and solutions. For feedback, comments and typos please e-mail [email protected] 2 We will examine production of several goods/services in later chapters. 3 If you are interested in such issues you should take ECO 370 (Economics of Organizations) or read the excellent books “ The Economic Nature of the Firm ” (edited by Louis Putterman) and Economics, Organization and Management by Milgrom and Roberts. 4 This exogenously given output may have been chosen as the revenue or the profit maximizing output. Regardless, we take this target output level as given (a parameter). Inputs "Black Box Firm" Output of a product/service
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University of Toronto, Department of Economics (STG). ECO 204, S. Ajaz Hussain. Do not distribute. 2 ECO 204 Chapter 11: Producer Theory the Basics (this version 2012-2013) 2. The Production Process (“ Production Function “) The black box firm uses its technology, management, and “production process” to transform inputs into output. Denote: means that the firm is getting “better” because of a technological “innovation” and/or managerial “improvement” (as would surely happen if the firm fired petulant Rotman MBAs and hired stellar Rotman Commerce students ). In ECO 204: In order to describe the production process we need to first describe th e firm’s “production set” , the set of all inputr bundles” that are physically available to the firm for use in its production process. Assuming there are inputs we a ssume that the “production set” – the set of all inputs that are physically available to the firm is: {( ) } The production set ” in producer theory is the counterpart of the
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