Production Decisions in Non-Strategic Environments

In the previous section, we derived how an agent facing a set of prices would choose the quantity demanded of each good or service to maximize their utility function. We also tested the amount of time that an agent might choose to work (i.e., the quantity of labor supplied) given market wages—where the agent trades off the additional goods they might purchase against the lost leisure time they must forgo. Here, we look at the other side of the market and test an agent's ability to operate a production technology to maximize profits. Facing market prices for all production factors (e.g., wages and the capital) and the market price of the good or service they produce, the agent chooses the quantity of each factor of production and the total output. Parallel to Consumption Decisions in Non-Strategic Environments, in Properties of Production Functions we first test general properties of production functions to ensure the agent can reason about substitution between factors, economies of scale in production, etc. Then in Deriving Factor Demand we solve the firm's optimal profit maximization problem to determine the optimal choice of factors of production and output given a set of market prices. Finally, in Comparative Statics with Production we test the agent's ability to reason about comparative statics on prices and their impact on factor demand and firm output.

Modules

1. 3.1Properties of Production Functions

   Production functions in these environments take continuous inputs of each factor, which lets us test an agent's ability to conduct marginal thinking when choosing the composition of inputs.

   7 elements: Diminishing Marginal Products, Marginal Products, Output Elasticity, Returns to Scale, Average Cost, Marginal Cost, Elasticity of Substitution

2. 3.2Deriving Factor Demand

   This module tests the agent's ability to act in the role of a profit maximizer in non-strategic situations where they take as given the price which they could sell goods they produce, and must pay for inputs to their production process at market rates (e.g., a competitive wage).

   3 elements: Expenditure Minimization, Profit Maximization, Duality of Profit Maximization and Expenditure Minimization

3. 3.3Comparative Statics with Production

   This module considers how agents reason about changes in the prices at which they can sell their goods, as well as changes in the costs of producing those goods.

   4 elements: Response of Optimal Labor to the Wage, Price Elasticity of Supply, Total Factor Productivity, Shephard's Lemma

4. 3.4Dynamic 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.

   2 elements: Dynamic Profit Maximization, Entry and Exit Decisions