1. The Firm and Optimal Input Use Overheads

2. A neoclassical firm is an organization that controls the transformation of inputs (resources it controls) into outputs (valued products that it sells), and earns the difference between what it receives in revenue, and what it spends on inputs. Nature of the firm

3. Profit Profit = Revenue - Cost

4. Objectives of the firm We assume that firms exist to make money, by choosing the optimal levels of inputs and output so they maximize profits

5. Technology and the firm The technology for a given production process is the set of all input and output combinations such that the output y can be produced from the given set of inputs x

6. The Producible Output Set P(x) The producible output set P(x) is the set of all combinations of outputs that are obtainable from a fixed level of inputs

7. Production Functions The production function is a function that gives the maximum output attainable from a given combination of inputs

8. Example production function

9. Production and factor costs in the short run Total (physical) product - TPP Total product (y) is the maximum quantity of output that can be produced from a given combination of inputs It is the value of the production function y = f (x 1, x 2,..., x n )

11. Marginal (Physical) Product (MPP) Marginal (physical) product is the increase in output that results from a one unit increase in a particular input

12. Marginal Revenue Product (MRP) The marginal revenue product of an input is the increase in output that results from a one unit increase in that particular input

13. Marginal Revenue Product (MRP) is given by For a competitive firm, MRP is given by

14. xyDMPPMRPMFC 0.00.00 10.0 1.014.50 14.50 72.50 10.0 2.028.00 13.50 67.50 10.0 3.040.50 12.50 62.50 10.0 4.052.00 11.50 57.50 10.0 5.062.50 10.50 52.50 10.0 6.072.00 9.50 47.50 10.0 7.080.50 8.50 42.50 10.0 8.088.00 7.50 37.50 10.0 9.094.50 6.50 32.50 10.0 10.0100.00 5.5 27.50 10.0 11.0104.50 4.5 22.50 10.0 12.0108.00 3.5 17.50 10.0 13.0110.50 2.5 12.50 10.0 14.0112.00 1.5 7.50 10.0 15.0112.50 0.5 2.50 10.0

15. Marginal Product & Marginal Revenue Product 0 10 20 30 40 50 60 70 80 0246810121416 Input DMPP MRP

16. Marginal Factor Cost (MFC) The additional amount that the firm has to pay for a factor when it hires one more unit of the factor is called marginal factor cost For a firm that is a price taker in the input market, marginal factor cost is equal to factor price MFC i = w i

17. The Profit Maximizing Output Level The marginal approach to profit maximization says that the firm should take any action that adds more to revenue than to cost

18. The Profit Maximizing Rule The firm should use another unit of the ith input as long as the marginal revenue product of the input is larger than the marginal factor cost of the input

19. Marginal Product & Marginal Factor Cost 0 10 20 30 40 50 60 70 80 0246810121416 Input MRP MFC x opt

20. Demand for a variable input (single input) When the firm only uses one variable input, the downward sloping portion of the marginal revenue product curve is the input demand curve The input demand curve tells us how many units of the input the firm will chose to employ at various prices

21. wxMRP 72.51.072.50 67.52.067.50 62.50 3.062.50 57.50 4.057.50 52.50 5.052.50 47.50 6.047.50 42.50 7.042.50 37.50 8.037.50 32.50 9.032.50 27.50 10.027.50 22.50 11.022.50 17.50 12.017.50 12.50 13.012.50 7.50 14.07.50 2.50 15.02.50

22. MRP MFC Input Demand MFC 1 MFC 2 MFC 3 0 10 20 30 40 50 60 70 80 0246810121416182022 Input $

23. Summary of results on the firm Profit Maximization p × MPP i = w i, i = 1, 2, …, n

24. The End