Economic Analysis of the Firm
Economic Analysis of the Firm ECO 6115
University of Central Florida
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Date Created: 10/22/15
Empirical Analysis of Production 39 and Cost Chapter 10 Maurice and Thomas 83911 Ed Objectives of Discussion Use of statistical techniques to estimate production and cost functions Focus on some specification issues for functional forms of equations Discuss problems in data collection and estimation of cost functions 39 Specification of Short Run Production Function We focus on short run not long run production and cost estimation 7 typically very dif cult to get data for the long run 7 functional forms are much more complicated Consider the linear specification for the production function Q aKbL cbL inthe shortrun What is wrong with the above Appropriate functional form For a linear production function 7 whenL0Qcgt0 r MPL is constant so law of diminishing returns is violated Need a cubic production function for appropriate shapes ofAP and MP curves QaK315 an Short run function becomes Q AL BL2 WhereA a andB qu2 Average and Marginal Product Q AL BLZ From the above we get AP 2 L A 2 MIP 3AL 2BL AL V Maximizing MP and AP A Solving formaximum points for each function we get B L M 3A B L 7 A 2A Problems in measuring costs Need to correct for in ation When using time series data Use appropriate de ator such as CPI or PPI Accounting cosw are o en different from economic costs 7 implicit costs not o en included 7 cost of capital not accurately measured depreciation capital gains or loss vintage ofcapital stock Speci cation of Cost Function lt Cost function should yield appropriate shape for C and MC functions TVC aQ bQZ cQ3 AVCabQ cQZ MC a 2bQ 3cQZ Restriction on parameters a gt 0 b lt 0 c gt 0 inimum AVC is at b 739 p Summary Appropriate functional forms need to be specified for both production and cost estimation 39 Parameter values need to have appropriate signs to ensure shape dictated by theory Data problems need to be addressed when considering cost estimation Pro t Maximization for Firms with Market Power Implementation of the Theory Chapter 12 Maurice and Thomas 8th Ed Objectives of Discussion a Find pro tmaximizing level of output for any rm with et power given estimates or forecasts of e The demand function e The average vanable cost function and e The marginal cost function Detennme whether or not the lm should operate given the rm s information above Discuss problems associated with a costplus pricing rategy and conditions under which costplus pricing leads to pro t maximization a Summary Estimate the demand function 7 Substitute forecasts for M as or other relevant variables 7 Solve for inverse demand function or P fQ e Solve for marginal revenue Estimate AVC and MC functions Find output level Where MR MC V Find pro t maximizing price 7397 Summary cont d 7 Check the shutdown rule Compute pro t or loss PAVCQ TFC Costplus pricing is a means of determining price by setting it equal to ATC plus of ATC as markup P l n ATC Where m is the markup on cost 7 Equivalent to pro t maximizing ifATC AVC constant and m 1 1E Multiple Plants Markets and Products Chapter 14 Maurice and Thomas 8th Ed Objectives of Discussion Discuss managerial decision making process when producing in more than one plant Discuss managerial decision making strategies for se 39 a oduct in more than one mar et Discuss strategies and outcomes when producing multiple producw that are related either in consumption or in production a Multiple Plants Firms producing in two plants a and b 7 Allocate productiori such that MCfMCb 7 Produce total output such that MRMcMcMch 7 Wherettota1 7397 Multiple Markets Ifa rm sells in tow distinct markets 1 and 2 it should allocate output sales such that MR1 MR2 Optimal level oftotzl output for rm is MK MC 7 where t total horizontal sum ofMRs 7 and each is sold at its own priceP1lt 12 iflEll lt lEzl 0rP1gt P2 iflEil gt lEzl Multiple Products Related in consumption For two producw x and y rm strategy is to produce up to MKEMCX and MRyMCy Since x and y are related in consumption MKi fQX and Qy as is MRy Both marginal conditions must be satis ed 39 simultaneous y Multiple Products Production Substitutes Firm produces two products x and y that compete for rm s limited production facilities Allocate facility so that MRPXMRPy In the long run optimal usage of facility is MRPt where t total from horizontal summation of MRPs Multiple Products Production Complements summary When rm produces two products x and y that are complemenw in production and in xed proportions from the common input the joint marginal revenue curve is the vertical summation of the two individual MRS MR and MRy over Which both MRS are positive Beyond Where one of the MRS becomes negative the MRj is the same as the MR for the remaining positive product r Summary