01-09-2012, 12:42 PM
PROFIT MAXIMIZATION
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The Nature of Firms
A firm is an association of individuals who have organized themselves for the purpose of turning inputs into outputs
Different individuals will provide different types of inputs
the nature of the contractual relationship between the providers of inputs to a firm may be quite complicated
Contractual Relationships
Some contracts between providers of inputs may be explicit
may specify hours, work details, or compensation
Other arrangements will be more implicit in nature
decision-making authority or sharing of tasks
Modeling Firms’ Behavior
Most economists treat the firm as a single decision-making unit
the decisions are made by a single dictatorial manager who rationally pursues some goal
usually profit-maximization
Profit Maximization and Input Demand
A firm’s output is determined by the amount of inputs it chooses to employ
the relationship between inputs and outputs is summarized by the production function
A firm’s economic profit can also be expressed as a function of inputs
Cross-Price Effects
No definite statement can be made about how capital usage responds to a wage change
a fall in the wage will lead the firm to substitute away from capital
the output effect will cause more capital to be demanded as the firm expands production
Important Points to Note:
If a firm is a price taker, its output decisions do not affect the price of its output
marginal revenue is equal to price
If the firm faces a downward-sloping demand for its output, marginal revenue will be less than price