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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 204 spring 2006

Class Slides for EC 204Spring 2006

To Accompany Chapter 3


The production function

The Production Function

Assume Constant Returns to Scale:

Full Employment Determines the Supply of Output:


The firm s demand for factors
The Firm’s Demand for Factors

Firms Maximize:

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


The division of national income
The Division of National Income

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.