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to produce and
then need to choose the best (K, L) combo to produce q
.
The best (K, L) pair is the cheapest one that still produces
q
.
The cost function, C(r , w, q
= f (K, L)
prod constraint
L = rK + wL + (q
f (K, L))
Brett Devine Production Theory
Necessary Conditions
Take the partial derivatives of the Lagrangian with respect to K, L,
and .
L
K
= r
f (K,L)
K
= 0 (1)
L
L
= w
f (K,L)
L
= 0 (2)
L
= q
f (K, L) = 0 (3)
Brett Devine Production Theory
Necessary Conditions
Manipulating equations 1,2, and 3 from the last slide we can reduce
the 3 conditions down to 2 conditions that should look familiar.
MRTS
K,L
=
MP
L
MP
K
=
w
r
Tangency Condition
q
and L
as functions of
(r , w, q
).
Brett Devine Production Theory
Properties of Cost Functions
Cost functions are functions of input prices r ,w and a
production constraint q
.
Cost is increasing in q
.
Cost is increasing in (r , w) together, not necessarily
individually.
Note: The cost function is frequently called the Total Cost
function and may only be a function of q in some problems.
Brett Devine Production Theory
Expansion Paths
Given r and w as xed, whenever we give the rm a production
quota q, the cost function will return the minimum cost of
producing q and will implicity choose the cheapest combination of
K and L. The rms expansion path is the set of cost minimizing
tangencies. We can trace out the expansion path be seeing where
all the optimal choices of (K, L) are for all levels of production q.
Brett Devine Production Theory
The Other Cost Functions
There are several important manipulations of the cost function
that are used for economic analysis.
Marginal Cost This is dened as MC =
C(r,w,q)
q
.
Average Cost This is dened as AC = C(r , w, q)/q which is just
average cost per unit produced.
Brett Devine Production Theory
Very Shortrun, Shortrun and Long Run
Decisions made by rms often require careful planning and are
aected by limitations on resources and time. It is important to
realize how a rm is capable of reacting to changes in the market
within certain time frames.
Very Shortrun Both capital K and labor L are xed.
Shortrun Only capital K is xed, labor L is free to be adjusted.
Longrun Neither capital K, nor labor L is xed, both are free
to move and be adjusted.
Brett Devine Production Theory
Shortrun Average Cost Curves
It can often be easier to analyze costs on a per unit produced basis
rather than just the total cost overall. The Shortrun idea
mentioned previously can yield us a Shortrun Total Cost function
by xing k. We dene the per-unit produced basis as Shortrun
Average Cost:
SAC =
shortrun total costs
total shortrun output
=
STC
q
In the Longrun nothing is xed and so capital and labor are
perfectly adjustable.
Brett Devine Production Theory