Dynamic Production Decisions

While Deriving Factor Demand tested the ability of agents to make static (i.e., within-period) decisions on the mix of input factors to maximize profits, many producer problems are inherently dynamic. For example, we can test if an agent can optimally choose the amount of capital to purchase given forecasts of future consumer demand and prices or choose how much to adjust the labor force in cases when labor is difficult to relocate due to frictions such as hiring and firing costs. Finally, agents are tested on their ability to make optimal entry and exit decisions based on their forecasted profits in an evolving market.

Elements

1. Dynamic Profit Maximization

   Choosing how much to increase capital today when tomorrow's output price is known or random and adjustment is costly.

2. Entry and Exit Decisions

   Deciding whether a competitive firm should enter a market in the long run or shut down in the short run, and finding the break-even and shut-down prices.