Class Slides for EC 204 Spring 2006. To Accompany Chapter 3. The Production Function. Assume Constant Returns to Scale:. Full Employment Determines the Supply of Output:. The Firm’s Demand for Factors. Firms Maximize: Profits = Revenue - Labor Costs - Capital Costs
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Class Slides for EC 204Spring 2006
To Accompany Chapter 3
The Production Function
Assume Constant Returns to Scale:
Full Employment Determines the Supply of Output:
Profits = Revenue - Labor Costs - Capital Costs
= PY - WL - RK
= PF(K, L) - WL - RK
Factor Demands are determined by:
MPL(K, L) = W/P
MPK(K, L) = R/P
Real Economic Profit = Y - (MPL x L) - (MPK x K)
Y = (MPL x L) + (MPK x K) + Real Economic Profit
Euler’s Theorem: Constant Returns to Scale implies:
F(K, L) = (MPK x K) + (MPL x L)
If factors of production are paid their marginal products, then
these factor payments sum to total output. Thus, CRS, profit
maximization, and competition imply that Economic Profit = 0.
Since owners of firms usually own the capital, their “profit”
is the payment to capital, rK.