Intermediate Microeconomic Theory

1
Intermediate Microeconomic Theory

• Firm Behavior

2
Profit Maximization

• Given its technology, we now want to develop a
  model of firm behavior.
• Standard assumption firms make decisions to
  maximize profits, or maximize total revenue minus
  total costs.
• where q f(x1,,xm)
• Decision process can be broken up into two parts
• What combination of inputs should firm use to
  produce any given amount of output? (Production)
• Given it makes the optimal production decision,
  how much should it produce/supply? (Supply)

3
Production

• We will consider first the Production decision.
• Key idea
• Consider any level of output for firm q
• If firm is producing q in the profit maximizing
  way, it must be producing q using the cost
  minimizing way (why must this be the case?
• So, key to modeling production behavior is to
  analyze how input choices affect costs.

4
Costs

• When economists think about costs, they think
  much more broadly than do accountants.
• Costs include not only direct costs that must be
  paid for, but indirect costs or opportunity
  costs
• Opportunity cost - Lost revenue from failing to
  use an input factor for next best use.

5
Costs

• Suppose you currently have a job at a music store
  for 10/hr. and you currently have 1000 in your
  bank account earning interest of 1/month.
• Now say you are thinking of getting into the
  granola bar business.
• To produce 1000 granola bars, you would need 40
  lbs of oats and 20 lbs of honey (which you would
  have to buy up front). It will also take you
  400hrs (1 month) to do the prep work and 200 hrs
  of oven time.
• Suppose
• Oats cost 10/lb, and honey costs 5/lb.
• The going rate for oven rental time rent oven
  time is 6/hr., but you already own an oven you
  can use.
• What would be your total economic cost of
  producing 1000 bars?

6
Iso-Cost Curves

• Granola bars might take fixed inputs for any
  given level of output, but we will also often
  want to think about good for which there are
  trade-offs in the production process.
• If we again consider the simple two-input case we
  can think of these trade-offs via Iso-cost
  curves.
• Iso-cost curves - all the combinations of inputs
  that cost the same amount.
• Ex Suppose w1 10 w2 20
• What is graph for the 100 Iso-cost curve?
• How about for the 200 Iso-cost curve?
• What happens when input prices change?
• So what is interpretation of slope of an iso-cost
  curve?

7
Production Decision

• Consider a firm with a technology given by a
  production function F(x1, x2) x1a x2b, and the
  price of the inputs are w1 1 and w2 2
• How would we graphically characterize the input
  bundle that this firm want to use to produce 100
  units of output?
• How do you interpret this?
• What about a different level of output, say q
  200?
• What if prices were w1 2 and w2 2?

8
Production Decision

• So firms decision regarding which input bundle
  to use to produce a given level of output is
  similar (but not identical) to individuals
  decision regarding the good bundle to use to
  produce utility.
• Individual - Chooses bundle that is on highest
  Indifference Curve, but is still on budget
  constraint for m.
• (Utility Maximization)
• Firm To produce q units of output, choose input
  bundle that is on lowest Iso-cost curve, but
  still is on Isoquant curve for q.
• (Cost Minimization)

9
Conditional Factor Demands

• In consumer theory, choice problem over good
  given different prices gives demand curve for
  goods.
• In producer theory, choice problem over different
  inputs given prices gives conditional factor
  demands.
• Denoted x1(w1, w2, q)
• conditional because it gives demand for inputs
  conditional on producing some amount q.

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Conditional Factor Demand Curve

• We can derive the Conditional Factor Demand Curve
  for a given input by choosing a given output
  level, then varying the price of one input while
  the holding prices of other inputs constant.
• How do we derive this graphically?
• How will this conditional demand curve change if
  we consider a higher level of output? How about
  higher prices for the other input?

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Conditional Factor Demands Analytically

• How would we derive conditional factor demand
  function analytically?
• What to conditions hold at optimal input bundle
  in example from above?
• How do we use these to derive optimal input
  bundle for any given q?

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Conditional Factor Demand Curve Analytically

• So what will conditional factor demand curve look
  like for input x1 given production function F(x1,
  x2) x10.5x20.5, w1 2 and w2 8?
• How about for input x2?
• So if x1 and x2 are only inputs (i.e. no other
  opportunity costs), how much will it cost to
  produce 100 units of output? How about 200?

13
Thinking about Conditional Factor Demand Curves

• Which would likely have a more elastic factor
  demand curve---tax preparers or medical doctors?

14
Is there (Middle Class) Life After Maytag?

• Describe the economics of the changes in labor
  demand for Maytag.

15
Is there (Middle Class) Life After Maytag?
K
K
700,000 isocost
1 million isocost
1.2 million isocost
q2000
q1000
q1000
900 LNewton

LClyde
1500
1000
Newton Factory
Clyde Factory
So how much money did Maytag save be
re-optimizing production?
Besides the economics, what else does the
article emphasize?