ABSTRACT
IN OUR discussion of the production function, we argued that technological considerations seldom prescribe exactly the quantities of factors required for producing a given output but allow some leeway and scope for variation. The nature and limitations of this leeway and of the firm’s freedom of choice between different combinations of factors and different rates of output were illustrated graphically by our isoquants and productivity curves. The question we now have to answer is how the firm makes use of its freedom of choice to maximize profit. This clearly depends on market conditions. Facing given prices in product and factor markets, and having its freedom of action circumscribed by its production function, the firm must make three decisions. It must decide (1) how to produce; (2) how much to produce; and, if it produces several products, (3) what combination of products to produce. The three decisions are not independent of each other, and all of them are determined by the same principle of profit maximization. It is only for the sake of convenience that they are discussed separately in the following pages.
