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Answers tutorials Microeconomics for EOR, Week 4

Exercise 1 Production function P (L, K) with labor L 0 and capital K 0 as inputs.
1. Marginal rate of technological substitution (of capital for labor) is
M RT S(L, K) =

M PL (L, K)
P (L, K)/L
dK
=
=
.
dL
M PK (L, K)
P (L, K)/K

(a) P (L, K) = 15K 1/2 L1/2 : M RT S(L, K) =

(15/2)K 1/2 L1/2

K
= ;
1/2
1/2
(15/2)K
L
L

7
(b) P (L, K) = 4K + 7L: M RT S(L, K) = ;
4
(K(K + L) KL)/(K + L)2
10KL
K2
: M RT S(L, K) =
(c) P (L, K) =
=
;
K +L
(L(K + L) KL)/(K + L)2
L2
4K 2
K
=
;
8KL
2L
(e) P (L, K) = min{3K, 4L}: M RT S(L, K) is not defined, because P is not

(d) P (L, K) = 4K 2 L: M RT S(L, K) =

partially differentiable.
2. Diminishing MRTS (strict convexity): M RT S(L, K) > 0 and
dM RT S(L, K)
M RT S(L, K) M RT S(L, K) dK
=
+

< 0,
dL
L
K
dL
where

dK
dL

= M RT S(L, K) is the slope of the isoquant at (L, K).

dM RT S(L, K)
K
1 K
2K
K
> 0 and
= 2 + ( ) = 2 < 0
L
dL
L
L L
L
when L > 0 and K > 0;

(a) M RT S(L, K) =

(b) dM RT S(L, K)/dL = 0, so not strict convex (but convex);

(c) M RT S(L, K) =

K2
dM RT S(L, K)
2K 2
2K K 2
>
0
and
=

+
( 2 ) =
L2
dL
L3
L2
L

2K 2
K
(1 + ) < 0 when L > 0 and K > 0;
3
L
L
K
dM RT S(L, K)
K
1
K
> 0 and
= 2 +
( ) =
(d) M RT S(L, K) =
2L
dL
2L
2L 2L
3K
2 < 0 when L > 0 and K > 0;
4L
(e) Isoquants contain straight pieces, so not strict convex (but convex).

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3. Average product of labor APL (L, K) = P (L, K)/L and scale economies index
of labor, being the change in percentage of output when labor input changes
P (L, K) P (L, K)
dP (L, K)/P (L, K)
|=1 =
/
=
in percentage, IL (L, K) =
d/
L
L
M PL (L, K)
.
APL (L, K)
7.5
1
= ;
15
2
7
7L
(b) APL (L, K) = 7 + 4K/L, IL (L, K) =
=
;
7 + 4K/L
7L + 4K
(a) APL (L, K) = 15K 1/2 /L1/2 , IL (L, K) =

(c) APL (L, K) =

10K
10K 2 /(K + L)2
K
, IL (L, K) =
=
;
K +L
10K/(K + L)
K +L

4K 2
= 1;
4K 2
(e) APL (L, K) = min{3K/L, 4}, IL (L, K) = 1 if L/K <

(d) APL (L, K) = 4K 2 , IL (L, K) =

3
4

and 0 if L/K > 34 .

4. Average product of capital APK (L, K) = P (L, K)/K and scale economies index
of capital, the percentage change of output when capital changes in percentage,
dP (L, K)/P (L, K)
P (L, K) P (L, K)
M PK (L, K)
IK (L, K) =
|=1 =
/
=
.
d/
K
K
APK (L, K)
1
7.5
= ;
15
2
4
4K
(b) APK (L, K) = 4 + 4L/K, IK (L, K) =
=
;
4 + 7L/K
7L + 4K
(a) APK (L, K) = 15L1/2 /K 1/2 , IK (L, K) =

10L
10L2 /(K + L)2
L
, IK (L, K) =
=
;
K +L
10L/(K + L)
K +L
8KL
(d) APL (L, K) = 4KL, IK (L, K) =
= 2;
4KL
(e) APK (L, K) = min{3, 4L/K}, IK (L, K) = 1 if L/K > 34 and 0 if L/K < 34 .
(c) APK (L, K) =

5. Index of scale economies: Change in percentage of output when all inputs change
dP (L, K)/P (L, K)
P (L, K)
L
in percentage, I(L, K) =
|=1 =

+
d/
L
P (L, K)
P (L, K)
K
M PL (L, K) M PK (L, K)

=
+
= IL (L, K) + IK (L, K) is the
K
P (L, K)
APL (L, K)
APK (L, K)
sum of the scale economies indices of each production factor. Decreasing, constant,
increasing returns to scale if I(L, K) <, =, > 1 (or equivalently P (L, K) <, =
, > P (L, K) for any (L, K) 6= (0, 0) and > 1).
(a) I(L, K) =

1 1
+ = 1, so constant returns to scale;
2 2

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4K
7L
+
= 1, so constant returns to scale;
7L + 4K 7L + 4K
L
K
+
= 1, so constant returns to scale;
(c) I(L, K) =
K +L K +L
(d) I(L, K) = 1 + 2 = 3 > 1, so increasing returns to scale;
(b) I(L, K) =

(e) P (L, K) = min{3K, 4L} = min{3K, 4L} = P (L, K), so I(L, K) = 1

and constant returns to scale.

Exercise 2 Same technologies as in exercise 1.

1. Expansion path is curve of conditional (on output) input demand vectors in the
(L, K)-plane and consists for given wage w > 0 and interest r > 0 of all points
(L, K) 0 satisfying M RT S(L, K) =

w
r

(for interior solutions).

K
w
w
= , so K = L, L 0, a
L
r
r
straight line (in the (L, K)-plane) with slope w/r;

(a) P (L, K) = 15K 1/2 L1/2 : M RT S(L, K) =

(b) P (L, K) = 4K + 7L: If

w
r

>

7
4

w
r

boundary solutions only), if

and boundary) solutions), and if

then K 0 and L = 0 (a straight line of

7
then
4
w
< 74
r

every (L, K) 0 (multiple (interior

then K = 0 and L 0 (a straight

line of boundary solutions only);

p
10KL
K2
w
(c) P (L, K) =
: M RT S(L, K) = 2 = , so K = w/rL, L 0, a
K +L
L
r
p
straight line with slope w/r;
K
w
w
(d) P (L, K) = 4K 2 L: M RT S(L, K) =
= , so K = 2 L, L 0, a straight
2L
r
r
line with slope 2w/r;
(e) P (L, K) = min{3K, 4L}: K =

4
L,
3

L 0, a straight line with slope

4
,
3

independent of w and r.
2. Elasticity of substitution =

L/K w/r

with L/K the conditional input

w/r L/K

demand ratio.
(a)

K
w
w/r
=
yields L/K = r/w = (w/r)1 , so = (w/r)2
= 1
L
r
(w/r)1
(Cobb-Douglas);

(b) w/r = 47 , so = (linear);

(c)

K2
w
1
w/r
1/2
3/2
=
yields
L/K
=
(w/r)
,
so

=
(w/r)

= 12 ;
L2
r
2
(w/r)1/2

(d)

w
1
w/r
K
=
yields L/K = r/(2w) = 12 (w/r)1 , so = (w/r)2 1
=1
2L
r
2
(w/r)1
2
(Cobb-Douglas);

(e) K = 34 L yields K/L = 34 , independent of w/r, so = 0 (Leontief).

3. Cost function C(y) = wL(y) + rK(y) at wage w = 1 and interest r = 4. Solve
M RT S(L, K) =
(a)

K
L

1
4

K(y) =
(b)

w
r

1
4

1
4

and P (L, K) = y to find (L(y), K(y)) (for interior solution).

yields K = 14 L, then y = 15( 14 L)1/2 L1/2 =

1
y
30

<

7
4

with cost C(y) =

4
y,
15

15
L,
2

so L(y) =

2
y
15

and

y 0;

= M RT S(L, K), so boundary solution (L(y), K(y)) = ( 71 y, 0)

with cost C(y) = wL(y) = 17 y, y 0;

(c)

K2
L2

1
4

K(y) =
(d)

yields K = 12 L, then y = 5L2 /( 12 L + L) =

3
y
20

with cost C(y) =

K
= 14 yields K = 12 L,
2L
1 1/3
y with cost C(y) =
2

9
y,
10

10
L,
3

so L(y) =

3
y
10

and

y 0;

then y = 4( 12 L)2 L = L3 , so L(y) = y 1/3 and K(y) =

3y 1/3 , y 0;

(e) Minimal cost when 3K = 4L = y so L(y) = 41 y and K(y) = 13 y with cost

7
C(y) = 41 y + 43 y = 1 12
y, y 0.

4. Cost function for technology y = P (L, K) = 10KL/(Kp+ L): M RT S(L, K) =

p
10 w/rL2
10 w
K2
w
L.
= r yields K = w/rL. Then y = P (L, K) = p
=
L2
w+ r
w/rL
+
L
p
1
Hence, conditional input demand L(y, w, r) = 10
(1 + r/w)y and K(y, w, r) =
p

1
1
(1
+
w/r)y with cost C(y, w, r) = wL(y, w, r) + rK(y, w, r) = 10
(w + wr +
10

1
rw+r)y = 10
( w+ r)2 y and (identical) average and marginal cost AC(y, w, r) =

1
M C(y, w, r) = 10
( w + r)2 as function of wage w, interest r, and output y 0.
5. Short run cost at wage w = 1, interest r = 4, and fixed capital K 0 = 4: Short run
production function y = f (L, K 0 ) = 40L/(4+L), so short run conditional demand
for labor is L(y; K 0 ) = 4y/(40 y), 0 y < 40. In the short run only less than
40 can be produced. Short run total cost is SRC(y; K 0 ) = wL(y; K 0 ) + rK 0 =
4y/(40 y) + 16 with variable cost V C(y; K 0 ) = wL(y; K 0 ) = 4y/(40 y) and
fixed cost F C(K 0 ) = rK 0 = 16, 0 y < 40. Short run average total cost is
AT C(y; K 0 ) = SRC(y; K 0 )/y = 4/(40 y) + 16/y with average variable cost
AV C(y; K 0 ) = V C(y; K 0 )/y = 4/(40 y) and average fixed cost AF C(y; K 0 ) =
F C(K 0 )/y = 16/y, 0 y < 40. Short run marginal cost is SM C(y; K 0 ) =


SRC 0 (y; K 0 ) = V C 0 (y; K 0 ) = 160/(40 y)2 , 0 y < 40.