Chapter 4 Cost Minimization

CHAPTER 4 COST MINIMIZATION
Minimization cost gives firstly another way to a firm to face competitive output markets and
second, the cost function allows us to model the production behavior of firms that don´t face
competitive output markets.
4.1. Calculuis analysis of cost minimization
Consider to find the cost-minimizing way to produce a given level of output
Analyze this constrained minimization problem using the method of Lagrange multipliers:
And differentiate it with respect to each of the choice variables, xi and Lagrange multiplier λ
the FOC characterizing an interior solution x* are
In a vector notation letting Df(x) be the gradient vector, the vector of partial derivatives of f(x)
we can write the derivative conditions as:
We can interpret these FOC by dividing the i-th condition by the j-th condition to get
When y is fixed, the problem of the firm is to find a cost-minimizing point on a given isoquant.
The equation of a constant cost curve, C=w1x1+w2x2 can be written as x2=C/w2-(w1/w2)x1.
Graphic of the Isoquant

These conditions are supposing that the factors are constant, but let (h1, h2) be a small change
in the factors 1 and 2 and consider the change associated to the output. Taylor series
expansion
In a matrix way
The change in h1 and h2 keeps costs constant must satisfy w1h1+w2h2=0. Substituting for wi
from the FOC for cost minimization, we can write this as:
Hence the FOC in terms of Taylor must vanish for movements along the isocost line. Intuitively,
the FOC tangent to the isocost curve implies output remains constant, and a SO-movement
implies output decreases.
This way of expressing the SOC generalizes the n factor case with a Hessian matrix of
production function is negative semidefinite subject to a linear constraint.
4.2. More on SOC
We can state the SOC in a way involving the Hessian matrix of the Lagrangian.
The FOC for cost minimization are that the first derivative of the Lagrangian with respect to λ,
x1, and x2 equals to zero. The SOC involves the Hessian matrix of the LAgrangian.
4.3. Difficulties
For each choice of w and y there will be some choice of x* that minimizes the costo of
producing y units of output. We will call the function that gives the optimal choice the
conditional factor demand function and write it as x(w,y) Note that conditional factor demands
depend on level of output produced as well as on the factor prices. The cost function is the
minimal cost at the factor prices w and output level y; that is, c(w,y)= wx(w,y).
The difficulties of minimization can be mentioned like:
 Firstly, the technology in question may not be representable by a differentiable

production function such as the Leontief production function.
 Second problem is the conditions are valid only for interior operating positions, they
must be modified if cost minimization point occurs on the boundary. The proper
conditions turn out to be:
 Third problem is continuity. We can restrict V(y) to bounded subset of V(y) that is just
to pick an arbitrary value of x, say x’. Clearly the minimal cost factor bundle must have
a cost less than wx’.
 The fourth problem is that the FOC may not determine a unique position of operation
of the firm. Considering global and local optimum
4.4. Conditional factor demand functions
In the minimization process and the conditional factor demands function x(w,y) must satisfy
the FOC
After finding the identities, therefore we can identify respect w1
These equations can be written in a matrix
After placing the Hessian, calculate the determinant. Also we know that is a negative number.
Also the determinant considering x2 the slope is positive.
4.5. Algebraic approach to cost minimization.
We consider the observed choices by a firm of output levels yt factor prices wt and factor
levels xt for t=1,…,T.
Refer this condition as the Weak Axiom of Cost Minimization, take two different observation
with the same output level a note that cost minimization implies that:
The first expression says the t-th observation must have the lower production costs at the t-th
prices; the second expression says that the s-th observation must have the lower production
cost at the s.th prices. Write the second inequity as:
Add it to the first, and get
The outer bound is given by:

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CHAPTER 4 COST MINIMIZATION

4.1. Calculuis analysis of cost minimization

Consider to find the cost-minimizing way to produce a given level of output

Graphic of the Isoquant

The difficulties of minimization can be mentioned like:

 Firstly, the technology in question may not be representable by a differentiable

4.4. Conditional factor demand functions

After finding the identities, therefore we can identify respect w1

These equations can be written in a matrix

4.5. Algebraic approach to cost minimization.

Add it to the first, and get

The outer bound is given by:

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