The properties of cost function

\We have shown earlier that cost functions have certain properties that follow from the structure of the cost
minimization problem; we have shown above that the conditional factor demand functions are simply the
derivatives of the cost functions. Hence, the properties we have found concerning the cost function will
translate into certain restrictions on its derivatives, the factor demand functions. These restrictions will be the
same sort of restrictions we found earlier using other methods, but their development using the cost function is
quite nice.

1) The cost function is nondecreasing in factor prices. It follows from

this that

2) The cost function is homogeneous of degree 1 in w. Therefore, the

derivatives of the cost function, the factor demands, are homogeneous of
degree 0 in w. (See Chapter 26, page 482).

3) The cost function is concave in w. Therefore, the matrix of second

derivatives of the cost function-the matrix of first derivatives of the
factor demand functions-is a symmetric negative semidefinite matrix.
This is not an obvious outcome of cost-minimizing behavior. It has
several implications.

a) The cross-price effects are symmetric. That is,

b) The own-price effects are nonpositive. Roughly speaking, the conditional

factor demand curves are downward sloping. This follows since
where the last inequality comes
from the fact that the diagonal terms of a negative semidefinite matrix
must be nonpositive.

Note that since the concavity of the cost function followed solely from
the hypothesis of cost minimization, the symmetry and negative semidefiniteness
of the first derivative matrix of the factor demand functions follow
solely from the hypothesis of cost minimization and do not involve any
restrictions on the structure of the technology.
Hence, the conditional factor demand curve slopes downward.

The properties of profit function

1) Nondecmsing in output prices, nonincreasing in input prices.

2) Homogeneous of degree 1 in p.

At the beginning of this chapter we proved that the profit function must satisfy certain properties. We have just
seen that the net supply functions are the derivatives of the profit function. It is of interest to see what the
properties of the profit function imply about the properties of the net supply functions. Let us examine the
properties one by one.
First, the profit function is a monotonic function of the prices. Hence, the partial derivative of ~ ( pw)i th
respect to price i will be negative if good i is an input and positive if good i is an output. This is simply the
sign convention for net supplies that we have adopted.
Second, the profit function is homogeneous of degree 1 in the prices. We have seen that this implies that the
partial derivatives of the profit function must be homogeneous of degree 0. Scaling all prices by a positive
factor t won't change the optimal choice of the firm, and therefore profits will scale by the same factor t.