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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 204Spring 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 = 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 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.
