Linking the Substitution and Output Effects of Production to Profit Maximization in the Intermediate Microeconomics Course (2024)

See all articles by Jeffrey Wolcowitz

Jeffrey Wolcowitz

Case Western Reserve University

Abstract

In a recent article, Thaver (2013) makes the case for including in intermediate microeconomics textbooks analysis of the substitution and output effects of a firm’s response to a change in the price of an input. In her analysis, Thaver assumes that the firm is constrained by a fixed budget for inputs, making the firm’s substitution and output effects analytically identical to the consumer’s substitution and income effects. Intermediate microeconomics textbooks typically do not assume a fixed budget for inputs when describing a firm’s profit-maximizing behavior. This paper removes the assumption of a fixed budget for inputs and provides a non-calculus presentation of substitution and output effects suitable for the intermediate course. Without this assumption, the substitution and output effects of the change in the price of an input must work in the same direction regardless of whether an input is normal or inferior, and the firm’s input demand curve, unlike a consumer’s demand curve for a good, must slope downward.