DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS                              ECONOMICS 1
                             Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                             Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                             Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                   Topic 4: Theory of the Firm
                                   Topic 4: Theory of the Firm
                                            Economics 1, Fall 2002
                                                 Andreas Bentz
                                 Based Primarily on Frank Chapters 9 - 12
                            Firms
                            Firms
                                demand:                              supply:
                                inputs:
                                labor,           production          output
                                capital
                               buy in factor                      sell in product
                                  market                             market
                                   cost                              revenue
                              Objective: firms are interested in profit = revenue - cost.
                                                                                    2
             © Andreas Bentz                                                                  page 1
                    DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS                                                                 ECONOMICS 1
                                           Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                           Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                           Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                                                       Production
                                                                        Production
                                                                        The Black Box
                                          Production
                                          Production
                                           X Production for a neoclassical economist is a
                                               “black box”:
                                                ƒ   We model production as a function that turns inputs
                                                    into output:
                                                               q = f(k, l)
                                                ƒ   where:
                                                     » q:      output
                                                     » k:      capital input
                                                     » l:      labor input
                                                     » f(·, ·): production function
                                                                                                                             4
                    © Andreas Bentz                                                                                                         page 2
               DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS                                     ECONOMICS 1
                               Short Run and Long Run
                               Short Run and Long Run
                                X Firms may not immediately be able to change the
                                   quantity of all inputs they use.
                                    ƒ Example: buildings, etc.
                                X The long run is defined as the shortest period of time
                                   in which a firm can change the quantity of all inputs it
                                   uses.
                                    ƒ An input whose quantity can be freely adjusted is a variable
                                      input.
                                X The short run is the period of time during which one or
                                   more inputs cannot be varied.
                                    ƒ An input whose quantity cannot be freely adjusted is a fixed
                                      input.
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                                Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                Dartmouth College, Department of Economics: Economics 1, Fall ‘02
                                      Production in the Short Run
                                      Production in the Short Run
                                         When not all inputs can be varied.
               © Andreas Bentz                                                                         page 3
                DARTMOUTH COLLEGE, DEPARTMENT OF ECONOMICS                                          ECONOMICS 1
                                 Short-Run Production
                                 Short-Run Production
                                  X Suppose a firm produces output according to
                                     the production function q = f(k, l).
                                  X Suppose that, in the short run, the amount of
                                     capital cannot be varied (fixed input) - assume
                                     it is fixed at k0.
                                  X We can then plot the amount of output
                                     produced as we vary the amount of labor
                                     (variable input).
                                  X This gives us the short-run production
                                     function.
                                                                                                  7
                                 Short-Run Production Function
                                 Short-Run Production Function
                                 q
                                                                     X The short-run production
                                                             f(k ,l)   function f(k0,l) plots the
                                                               0       quantity of output (total
                                                                       product), as one input
                                                                       (labor) is varied (holding
                                                                       capital fixed at k0).
                                                                 l
                                                                                                  8
                © Andreas Bentz                                                                               page 4