3 Comments

Brian, thank you. As always, an interesting, thought provoking summary of an interesting, complex topic. I do have a request, though: didn't particularly get the essence of the para "Panzar proves two important results. First, there should always be excess capacity. The idea is that with a neoclassical production function, more capital doesn’t just provide capacity but is also a substitute for the variable costs. At the optimum solution, the marginal cost of capital should equal the marginal cost of other inputs and you shouldn’t be “at capacity”. This is an analog of the more traditional result that firms should never drive the marginal product of any costly input to zero. The firm should have “excess’ production capabilities." Any way this all has a more simple English interpretation? Would make it more clear for me.

Expand full comment

Sorry about that. You're right. It's not clear. Probably not in my head either. Let me try another framing.

First, it is never optimal to drive marginal product of some input to zero. You're paying a cost for the input (say natural gas at a gas powerplant) but it's not generating any more output. You should buy less gasoline. Does that make sense.

Then a true capacity means that you cannot increase output anymore, regardless of whatever other inputs you use. So if you're at capacity, each input (again gas) cannot give you any more output, by assumption. Its marginal output is zero. So just as above, that cannot be optimal.

Expand full comment

Thanks Brian. Hope this'd clear things up. I'll re-read and get back to you in case there is anything still not clear

Expand full comment