Firm optimisation

Hi, I'm Dr. Sangaralingam Ramesh. In this talk, we'll be discussing Firm Optimisation, how firms optimize their production and seeking to answer the question of how do firms optimize their behavior?

So, in order to discuss firm production behavior, we need to define the production function. In this case, the production function can be represented mathematically by Y as a function of capital,K, and labour, L. The production function is a mathematical technical relationship between the quantities of capital, K, and the quantities of labour, L, used to produce a specific level of output, Y. In this case, the level of output,Y, is the maximum output which can be produced for a given combination quantity of capital, K, and labour, L, using a given level of technology. It is a purely mathematical or technical relationship. The same output, however, could not be produced with fewer resources. Economists, also, assume that production is technologically efficient. In other words, the maximum level of output can be produced for a specific combination of capital, K, and labor, L, for a given level of technology. However, when we consider the production function, economists, also, make a distinction between the short run and long run. So, in the context of a firm's production in the short run, it is assumed that the firms can vary the quantity of labor used in production, but not the quantity of capital used in production. In this case, we can think of capital, K, as the number of machines in the factory or the number of factories which the firm operates. Simply, because in a short time period the firm is unable to negotiate contracts with the suppliers of machines to buy more machines and neither can it negotiate with construction companies and landowners to buy land and build new factories. So, we assume in the short run that capital, K, is constant but, the firm can hire as many workers, represented by L, as possible. However, in the long run, a longer period of time, economists assert that the firm is able to change both factors capital, K, the number of machines and factories available and used in production as well as the quantity of labor, L, used in production.