Firm Behavior


Ziggy loves his grandmother's cookies very much. (He loves his grandmother too - just for the record). Since he was a child, he has told her: "The world needs your cookies" Flattered, his grandma eventually started a cookie company with him when he was old enough to manage it.

Like any other company they have estimated the number of cookies they need to produce. The problem they face is the following: what level of labor and capital do they need? They need:

  1. Labor: Some grandmas (everybody knows that grandmas make the best cookies)
  2. Capital: To simplify, professional ovens.


This chapter has one main goal: to understand hot to minimize long-run costs. Getting there requires understanding the following topics:

  1. Production Function — Given the number of bakers and ovens, the company can calculate the number of cookies produced
  2. Marginal Rate of Technical Transformation — Cost-wise, a grandma is worth some ovens
  3. Marginal Rate of Technical Substitution — Production-wise, a grandma is worth some ovens. How? A new grandma will be making more batter that she can stuff in the remaining ovens. In more extreme conditions, the grandma could make do with microwaves, pans, or even create an oven with clay. (Marginal Rate of Substitution)
  4. Long-Run Cost Maximization — The company minimizes costs when a grandma is worth the same number of ovens both cost-wise and production-wise.

This chapter has additional topics:

  1. Returns to Scale — What happens if Ziggy hires twice as many grandmas and buys twice as many ovens?
  2. Short-Run Production — Imagine that they have accepted to produce more cookies than usual for a special grandma bakeoff event. The company cannot install ovens overnight but can call in more grandmas. How many grandmas should work that day?

What does that tell about you?

This chapter is quite down to earth. It's just the mathematical formalization of how firms operate for pretty much anything you can buy: potatoes, scissors, hair extensions, TVs, buttons on remote controls, huge boxes of protein powder, cute little fluffy bunny toys (yep, really anything). Companies estimate whether you will buy their product, and thus, they estimate the total quantity to produce. From there, they hire people (possibly you) and purchase equipment.