Comprehensive Study Guide: Producer
Theory
Based on Intermediate Microeconomics by Hal R. Varian
Contents
1 Introduction 2
2 Technology (Chapter 18) 2
2.1 The Production Function . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.2 Isoquants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.3 Marginal Product (M P ) . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.4 Technical Rate of Substitution (TRS) . . . . . . . . . . . . . . . . . . . . 3
2.5 Returns to Scale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
3 Profit Maximization (Chapter 19) 3
3.1 Short-Run Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
3.2 Long-Run Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
4 Cost Minimization (Chapter 20) 4
4.1 Isocost Lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4.2 The Tangency Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4.3 Conditional Factor Demands . . . . . . . . . . . . . . . . . . . . . . . . . 4
5 Cost Curves (Chapter 21) 4
5.1 Types of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
5.2 Average and Marginal Costs . . . . . . . . . . . . . . . . . . . . . . . . . 5
6 Firm Supply (Chapter 22) 5
6.1 The Supply Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
6.2 Shutdown Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
7 Conclusion 6
1
, Intermediate Microeconomics Study Guide: Theory of the Firm
1 Introduction
While Consumer Theory focuses on maximizing utility subject to a budget constraint,
Producer Theory focuses on firms. The firm’s objective is typically to maximize
profit subject to technological constraints.
The analysis is divided into two stages:
1. Technology: What is physically possible to produce?
2. Economics: What is the cheapest way to produce (Cost Minimization) and how
much should be produced to maximize gain (Profit Maximization)?
2 Technology (Chapter 18)
Technology defines the relationship between inputs (factors of production) and outputs.
2.1 The Production Function
Let x1 and x2 be inputs (e.g., Labor and Capital) and y be the output.
y = f (x1 , x2 )
This function describes the maximum amount of output possible for a given combination
of inputs.
2.2 Isoquants
An isoquant is the set of all input combinations (x1 , x2 ) that produce the exact same
level of output ȳ.
• Analogous to Indifference Curves in consumer theory.
• Slope: The slope of the isoquant is the Technical Rate of Substitution (TRS).
2.3 Marginal Product (M P )
The additional output produced by using one more unit of a specific input, holding other
inputs constant.
Marginal Product
∂f ∂f
M P1 = and M P2 =
∂x1 ∂x2
Diminishing Marginal Product: Usually, we assume that as you add more of one
2
factor (holding others fixed), the additional output generated decreases ( ∂∂xf2 < 0).
1
2
Theory
Based on Intermediate Microeconomics by Hal R. Varian
Contents
1 Introduction 2
2 Technology (Chapter 18) 2
2.1 The Production Function . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.2 Isoquants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.3 Marginal Product (M P ) . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
2.4 Technical Rate of Substitution (TRS) . . . . . . . . . . . . . . . . . . . . 3
2.5 Returns to Scale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
3 Profit Maximization (Chapter 19) 3
3.1 Short-Run Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
3.2 Long-Run Maximization . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
4 Cost Minimization (Chapter 20) 4
4.1 Isocost Lines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4.2 The Tangency Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
4.3 Conditional Factor Demands . . . . . . . . . . . . . . . . . . . . . . . . . 4
5 Cost Curves (Chapter 21) 4
5.1 Types of Costs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
5.2 Average and Marginal Costs . . . . . . . . . . . . . . . . . . . . . . . . . 5
6 Firm Supply (Chapter 22) 5
6.1 The Supply Rule . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
6.2 Shutdown Condition . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
7 Conclusion 6
1
, Intermediate Microeconomics Study Guide: Theory of the Firm
1 Introduction
While Consumer Theory focuses on maximizing utility subject to a budget constraint,
Producer Theory focuses on firms. The firm’s objective is typically to maximize
profit subject to technological constraints.
The analysis is divided into two stages:
1. Technology: What is physically possible to produce?
2. Economics: What is the cheapest way to produce (Cost Minimization) and how
much should be produced to maximize gain (Profit Maximization)?
2 Technology (Chapter 18)
Technology defines the relationship between inputs (factors of production) and outputs.
2.1 The Production Function
Let x1 and x2 be inputs (e.g., Labor and Capital) and y be the output.
y = f (x1 , x2 )
This function describes the maximum amount of output possible for a given combination
of inputs.
2.2 Isoquants
An isoquant is the set of all input combinations (x1 , x2 ) that produce the exact same
level of output ȳ.
• Analogous to Indifference Curves in consumer theory.
• Slope: The slope of the isoquant is the Technical Rate of Substitution (TRS).
2.3 Marginal Product (M P )
The additional output produced by using one more unit of a specific input, holding other
inputs constant.
Marginal Product
∂f ∂f
M P1 = and M P2 =
∂x1 ∂x2
Diminishing Marginal Product: Usually, we assume that as you add more of one
2
factor (holding others fixed), the additional output generated decreases ( ∂∂xf2 < 0).
1
2
