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KN-EC221 - Optimising Behaviour

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4 views

KN-EC221 - Optimising Behaviour

Uploaded by

amitbhartiya.ecell
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Optimizing Behaviour

Prof. K. Narayanan
Department of Economics, IIT Bombay
EC 221 Intermediate Microeconomics I
Optimising Behaviour
Entrepreneur purchases X1 and X2 in perfectly competitive markets at constant unit prices.

Total cost is given by

Where r is the price of variable inputs b is the cost of any fixed inputs
Isocost line is the locus of input combinations that may be purchased for a specified total cost.

Slopes of isocost line equal the negative of the input price ratio.
The intercept of an isocost line on the x1 axis [(C – b)/r1] is the amount
of X1 that could be purchased if the entire outlay, exclusive of the cost
of the fixed inputs, were expended upon X1 and the intercept on the x2
axis is also similar.
The greater the total outlay to which an isocost line corresponds, the
greater the intercepts on X1 and X2 axes and therefore further it lies
from the origin.

#Like a consumer maximising his/her utility, the entrepreneur would


desire to obtain the greatest possible output for a given cost outlay.
Constrained Output Maximisation

Obtain the greatest possible output for a given cost outlay

Partial derivatives of V with respect to x1 x2 and


Solving first two equations

So,
Second order conditions require that the relevant bordered Hessian determinant be
positive

The second order conditions may be utilised to demonstrate that the rate of change of
the slope of the tangent to an isoquant must be positive ( at the point of tangency with
an isocost line.

The assumption that the production function is regular strictly quasi-concave will
ensure that the second-order condition is satisfied whenever the first-order conditions
are.
Constrained cost minimisation

Minimise the cost of producing a prescribed level of output

Partial derivatives with respect to x1 x2 and


Or,

The first order conditions for minimisation of cost subject to an output constraint are similar to those
for the maximisation of output subject to a constraint.

The second order condition requires that the relevant bordered Hessian determinant to be
negative:
Substituting and

Since

The second order condition is the same as that for constrained output maximisation case
The locus of tangency points gives the expansion path of the firms.
The expansion path is an implicit function of x1 and x2
Profit Maximisation

The entrepreneur’s ultimate aim is to maximise profit rather than the solution of constrained
maximum and minimum problems.

Profit is the difference between total revenue and total cost.


Profit is a function of x1 and x2 and is maximised with respect to these two variables.

First order conditions

We have,

And,

The first order conditions of profit maximisation require that each input be utilised up to a point
at which the value of its MP equals its price.
Second order conditions require that the principal minors of the relevant Hessian determinant alternate in
sign

And

The second order conditions strictly require the production function to be concave in the neighbourhood
of the point at which the first order conditions are satisfied, if such a point exists.
If the production function is strictly concave then the point at which the first order conditions are satisfied
gives the unique the profit maximising solution.

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