Chapter 3 - Firms Flashcards
(36 cards)
production function
the mapping that tells us, for a given set of inputs, how much output a firm is able to produce
isoquant curves
combinations of inputs that lead to a given level of output
perfect complements (isoquants)
A perfect complement is a good that must be consumed with another good.
L-shaped isoquants
perfect substitutes
A perfect substitute is a situation where two goods are viewed as identical, both give you the same output
straight isoquant
Cobb-Douglas production function
q=K^α L^β
intermediate case for inputs: neither perfect compliments nor perfect substitutes
law of diminishing marginal returns
for a given output level, using less L leads to need to use more K to compensate for the decrease in L; and the further decrease in L, the greater the increase in K is required to compensate for the decline in L.
Reflecting marginal returns, isoquants are ** curves; the closer compliments two inputs are, the more ** the corresponding isoquants are
convex
Total factor productivity
q = ω K^α L^β
given two firms with the same quantity of inputs, the firm with a higher ω is able to produce a higher output level
cost minimization
given a desired output level and given input prices, we determine the input mix that minimises cost
cost minimization = utility minimization
consumers seek the highest utility level consistent with a certain budget set; firms seek the lowest cost consistent with a certain output level (tangency)
production function is close to perfect complements
increase in cost of capital leads to a lower demand for labor
negative cross price elasticity
production function is close to perfect substitutes
increase in the price of capital leads to a higher demand for labor (positive cross-price elasticity)
cost function
shows the least total cost of inputs the firm needs to pay in order to produce output q
different types of costs
fixed cost, variable cost, total cost, average cost, marginal cost
(1) is the appropriate cost concept to decide how much to produce, whereas (2) is the appropriate cost concept to decide whether to produce at all
(1) marginal cost
(2) average cost
incremental revenue
the difference between total revenue from selling one unit and total revenue from selling no units
the level of output should be chosen so that the value of incremental revenue is as close to incremental cost as possible
optimal pricing: calculus approach
the profit maximizing output level is such that marginal revenue is equal to marginal cost
Elasticity rule of optimal pricing (Lerner Index)
The lower the price elasticity of demand (in absolute value) the higher the price-cost margin should be set
The price-cost margin is usually taken as an indicator of market power because…
…the larger the margin, the larger the difference between price and marginal cost, that is, the larger the distance between the price and the competitive price.
price markup
k = (p-MC) / MC k = 1 / (-ϵ-1)
Agency theory
a principal who wants an agent to act in the principal’s interest but possesses less information than the agent
labor market discipline
since managers don’t stay with the same firm forever, they are interested in creating a reputation for being good managers. This reputation effect may help provide mangers with the proper incentives
product market discipline
when product market competition is very intense, managers have to put more effort in maximizing profits. Competitors provide useful signals about the firm’s productivity, so they reduce the shareholder’s information disadvantage with respect to the manager.
