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August 29, 2006
The Simple Classical Model
The Classical Model builds on the understanding achieved via supply and demand. It focuses on a production function Y = f(K,N), where K is capital and N is labor.
The standard Theory of the Firm presents profit maximization with one variable factor of production (labor) using a U-shaped average cost curve and a marginal cost curve. This approach considers the profit maximizing quantity of output. (Capital is taken to be fixed in the short run.)
The Classical Model considers the profit maximizing quantity of labor hired. Firms hire up to the point where the cost of an hour of labor W is just equal to the value P*MPN of the output produced.
These two approaches are equivalent views of the same profit maximizing decision. The marginal cost is W/MPN so the upper diagram shows P = W/MPN. The lower diagram shows W = P*MPN.
Posted by bparke at August 29, 2006 02:37 AM