The John Bates Clark Model

Like any other unit, a firm is also limited by the technology available. Thus, it can increase its outputs only by increasing its inputs. As usual, this will be expressed by a production function. The output that a firm can produce depends on the land, labor and capital the firm puts to work.
In formulating the neoclassical theory of a firm, John Bates Clark took over the classical categories of land, labor and capital and simplified them in two ways. These are as follows:
1. He assumed that all labor is homogenous-- One labor hour is a perfect substitute for any other labor hour.
2. He ignored the distinction between land and capital, grouping together both kinds of non-human inputs under the general term “capital.” And he assumed that this broadened “capital” is homogenous.
Ofcourse, the simplifying assumptions are not true. John Bates Clark’s conception of a firm is highly simplified, like a map at a very large scale. In more advanced economics, one can get rid of the simplifying assumptions and deal with a much more realistic “map” of a business firm.
In the John Bates Clark model, there are some important differences between labor and capital and they relate to the long and short-run.

Theory of Production

After reading this lesson, you would be able to:

1. Define production function, isoquants, marginal product, price discrimination, monopsonist and the all-or-nothing demand curve.

2. Define increasing, decreasing and constant returns to scale.

3. Distinguish between income and substitution effects.

4. Distinguish between an individual buyer’s demand curve and the industry demand, and between industry demand and the demand curve facing an individual seller.

5. Compute marginal revenue from the demand curve of the seller when that demand curve is given in the form of a table.

6. Compute marginal resource cost from the supply curve of the buyer when supply curve is given in the form of a table.

7. Explain why marginal resource cost equals price for a buyer who is a price taker. 

8. Explain why marginal revenue equals price for a seller who is a price taker, and why marginal revenue is less than price for a seller who is a price maker.

9. Explain what the law of diminishing returns is and under what conditions it holds .

10. Explain why the demand curve, the supply curve for resources and the production function can be treated as boundaries.