Microeconomic Theory I

Nithin M
Junior Research Fellow

Indian Institute of Technology-Kharagpur

Some prelude

“Producers (firms) are just like consumers, but they

maximize profit instead of utility.”
Producer’s problem- Maximize Profits
Production function- relationship between inputs and
outputs.
• continuous
• strictly increasing
• quasi-concave
Q = f(x, γ)

An isoquant is the locus of all the combinations of factors

for producing a given level of output. can be classified
according to its shape

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Some prelude (cont.)

• Linear isoquant- perfect substitutability of factors of

production
• Input-output isoquant- strict complementarity of factors of
production. Also called Leontief isoquant.
• Kinked isoquant- limited substitutability of factors of
production. Also called activity analysis isoquant or linear
programming isoquant.
• Smooth-convex isoquant -used extensively in traditional
analysis.
The isoquants cannot intersect.
The slope of the isoquant depicts the degree of
substitutability of the factors of production.

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Some prelude (cont.)

The slope of the isoquant decreases as we move

downwards along the isoquant implying increasing
difficulty in substituting K for L.
Slope of isoquant is known as Marginal rate of technical
substitution or marginal rate of substitution of factors.
∂f(.)
∂K MPL
MRTSL,K =− = ∂L
=
∂L ∂f(.) MPK
∂K

Elasticity of substitution
d(K/L)
K/L
σ= d(MRS)
MRS

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Some prelude (cont.)

homogenous function Y1 =f(L,K), Y2 =f(aL,aK) , if a can be

factored out then the function is homogenous.
If, Y= av f(L, K),v is the degree of homogenity =1 CRS, <1
DRS, >1 IRS
Isoclines - is the locus of points of different isoquants
where the MRTS and K/L ratio is constant.
Isocost line is the locus of all combinations of factors the
firm can purchase with given expenditure.

C = rK + wL

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Some prelude (cont.)

The Profit Maximisation Problem

Choose production plan y ∈ Rn from production
possibilities set Y ⊆ Rn to maximize profit

max p.y = max p.f(x, γ) − C

y∈Y y∈Y

The firm’s problem is in fact to choose y as p is

determined the market.
Firm chooses the most efficient production plan
Producer’s equlibrium

∂Q/∂xj pj
=
∂Q/∂xk pk

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Some prelude (cont.)

Short-run and Long run- Variable proportions, returns to

scale and expansion paths
Profit function-properties
• Increasing in output prices and decreasing in input prices
• Homogenous of degree 1
• Hoteling’s lemma
Conditional factor demands
Shepherd’s lemma
Total cost function

C = c(r, w, q)

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Some prelude (cont.)

Cost minimisation problem- Consumer theory analogue

min w.L + r.K

L, K ∈ R+
n

s.t. q(K, L) ≥ q̄

Average and Marginal Costs- Relationship

Short run and long run costs- Relationship

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