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Understanding Production Functions & Profit Maximization

Learn how constant returns to scale, full employment, and factor demands influence output supply and profit maximization within firms. Delve into national income division, Euler’s Theorem, and economic profit in a competitive market.

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Understanding Production Functions & Profit Maximization

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  1. Class Slides for EC 204Spring 2006 To Accompany Chapter 3

  2. The Production Function Assume Constant Returns to Scale: Full Employment Determines the Supply of Output:

  3. 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

  4. 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.

  5. Demand for Goods and Services

  6. Equilibrium in Goods Market

  7. Equilibrium in Financial Markets

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