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# Prot Function

Cost minimization

Exercises of Microeconomics

## Prot Function and Cost Minimization (Ch. 3-4 Varian)

Fabio Tramontana (University of Pavia)
slides available at: http://tramontana.altervista.org/teaching.html

## PhD in Economics at L.A.S.E.R.

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Exercises Micro

Prot Function
Cost minimization

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

## A competitive prot-maximizing rm has a prot function

(w , w ) = (w ) + (w ). The price of the output is normalized
to be 1.
(a) What do we know about the rst and second derivatives of the
functions (w )?
1

## Remember that the prot function must be nonincreasing in input

prices and convex, so:
i0 (wi ) 0

and

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i00 (wi ) 0 .

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Prot Function
Cost minimization

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3.1
3.2
3.3
3.4
3.5

## (b) If x (w , w ) is the factor demand function for factor i , what is

the sign of x / w ?
i

## Given that in the prot function the two inputs appears in an

additive form, one factor does not inuence the optimum value of
the other, so:
xi / wj = 0.

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Prot Function
Cost minimization

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3.1
3.2
3.3
3.4
3.5

## (c) Let f (x , x ) be the production function that generated the

prot function of this form. What can we say about the form of
this production function? (Hint: look at the rst order conditions.)
1

We have seen that the demand for a factor only depends on its
price. So, the marginal product of each factor must only be a
function of the amount of the factor itself. It follows that:

f (x , x
1

) = g1 (x1 ) + g2 (x2 ).

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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Exercise 3.2

## Consider the technology described by y = 0 for x 1 and y = ln x

for x > 1. Calculate the prot function for this technology.
Note that we are looking for an expression in which prots does
only depend on prices:
(p , w )

## in other words we need the demand function x (p , w ) and the supply

function y (p , w ).

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Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Solution

Demand function and supply function come from the rst order
condition:
from which we have that:

p /x = w ,

## x (p, w ) = p/w and y (p, w ) = ln(p/w )

that gives us the prot function:
(p , w ) = py (p , w ) wx (p , w ) = p ln(p /w ) p

but given that the rm may always choice x = 0 to avoid negative
prots, we have:
(p , w ) = max {p ln(p /w ) p , 0} .
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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Exercise 3.3

## Given the production function f (x , x ) = a ln x + a ln x ,

calculate the prot-maximizing demand and supply functions, and
the prot function. For simplicity assume an interior solution.
Assume that a > 0.
1

## If we denoted by w and w the factors' prices and p the output

price, we have the following rst-order conditions:
1

p
w
x
p
a w
x
a

=0

=0

## that can be solved for the factor demand functions.

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Exercise
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Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Solution

We have:

p
w
p
x =a
w
x

= a1

## that inserted in the objective function give us the prot function:

p
(p , w , w ) = p a ln a
w
"

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p
+ a ln a
w
2

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a1 a2

Prot Function
Cost minimization

Exercise
Exercise
Exercise
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Exercise

3.1
3.2
3.3
3.4
3.5

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Exercise 3.4

## Given the production function f (x , x ) = x 1 x 2 , calculate the

prot maximizing demand and supply functions, and the prot
function. Assume a > 0. What restrictions must a and a satisy?
1

pa x
pa x
1

a1

1
a2

1
1

x
x

2
2
2
1

w1 = 0
w2 = 0

## and solve them for the factor demands.

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Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Solution

w
pa

2 =

! a1

1a1
a2

pa

w
pa

! a1

a2 1

1a1
a2

w2 = 0

## from which, after some algebra, we have the demand function of

the rst factor:
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Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Solution

w
pa

2
a2

w
pa

a2
1 +a2 1

!a

## Note that in order to be meaningful (that is, inputs are normal

goods), we must have:
a +a < 1
1

## that is decreasing returns to scale.

The other input demand function and the prot function are now
easily obtainable.
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Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

3.1
3.2
3.3
3.4
3.5

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Exercise 3.5

## Given the production function f (x , x ) = min {x , x } , calculate

the prot maximizing demand and supply functions, and the prot
function. What restrictions must a satisy?
a

The important note to start the exercise is that the rm will never
use dierent amounts of inputs to produce a certain level of output.
In fact, if not the rm may reduce the amount of the input that is
more used and still produce the same level of output. So we can
assume that:

= x2

## and the production function becomes:

f (x , x
1

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) = x1a
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Exercise
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Prot Function
Cost minimization

3.1
3.2
3.3
3.4
3.5

Solution

px

a
1

w1 x1 w2 x2

pax

(w 1 + w 2 ) = 0

+ w2

(a1)

pa

## that is meaningful provided that a < 1.

Supply and prot functions come out easily.
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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

4.3
4.4
4.6
4.7
4.8

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Prot Function
Cost minimization

Exercise
Exercise
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Exercise

4.3
4.4
4.6
4.7
4.8

Exercise 4.3

## A rm has two plants with cost functions c (y ) = y /2 and

c (y ) = y . What is the cost function for the rm?
1

2
1

The right way to calculate how much the rm should produce with
each plant, consists in equating the marginal costs, obtaining:

=1

which means that if the rm is producing one unit of output with
the rst plant, it is indierent to produce a little bit more with one
plant or the other one.
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Prot Function
Cost minimization

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4.3
4.4
4.6
4.7
4.8

Solution

Note that the marginal costs of the second plant are xed and equal
to 1, while the marginal costs of the rst plant are lower (resp.
higher) than 1 if the production is lower (resp. higher) than 1.
Putting together these facts you have the cost function:

y /2
if y < 1
y 1/2 if y > 1 ,
where y 1/2 is obtained considering y = y + y that is
y = y y = y 1.
c (y ) =

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Exercises Micro

Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

4.3
4.4
4.6
4.7
4.8

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Exercise 4.4

A rm has two plants. One plant produces output according to the
production function x x . The other plant has a production
function x x . What is the cost function for this technology?
a
1

b
1

## This case is similar to the EXAMPLE in the text. So, let us

proceed similarly.
The cost minimization problem for the rst plant is the following:

c (w , y ) = min
w x +w x
1, 2
such that x x = y
x

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a
1

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Exercise
Exercise
Exercise
Exercise
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Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Solution

## We can take the constraint, solve it for x and rewrite the

minimization problem as follows:
2

minw x + w y 1a x
1

x1

a
1
a

## from which we obtain the f.o.c.:

w y 1a x 1a = 0

1a
that permit us to obtain the conditional demand for factor 1:
1

x (w , w , y ) =
1

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a w
1a w

1a

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Prot Function
Cost minimization

4.3
4.4
4.6
4.7
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Solution

x (w , w , y ) =
2

a w
1a w

a

c (w , w , y )
1

1a
a a 1a
+ 1a a
= 1a a
w1 w2 y

## so the cost function is of the form c (y ) = A(a, w , w )y and

mutatis mutandis for the second plant we have
c (y ) = B (b, w , w )y .
1

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Prot Function
Cost minimization

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Exercise
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4.3
4.4
4.6
4.7
4.8

Solution

Given that the marginal costs are xed, the rm will always use the
plant with lower marginal costs.
That is:

c (y ) = min {A, B } y .

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Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

4.3
4.4
4.6
4.7
4.8

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Exercise 4.6

## A rm has two plants with cost functions c (y ) = 4 y and

c (y ) = 2y . What is its cost of producing an output y ?
1

## If you calculate and equate the marginal costs, obtain:

MC (y
1

) = MC2 (y2 )

4y2 = y1
1

and by using y = y + y :
1

4
5

1
5

## so the rm produces more with technology 2... how is it possible?

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Prot Function
Cost minimization

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4.4
4.6
4.7
4.8

Solution

## It is explainable by proving that we obtained a constrained

MAXIMUM and not minimum.
In fact, the cost function is concave and not convex. You can also
look at the second-order conditions.
The minimum is a corner solution, that is
The rm will produce all output at the cheaper plant:

c (y ) = 2 y .

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Prot Function
Cost minimization

Exercise
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Exercise
Exercise
Exercise

4.3
4.4
4.6
4.7
4.8

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Exercise 4.7

## The following table shows two observations on factor demand

x , x , factor prices w , w , and output y for a rm. Is the behavior
depicted in this table consistent with cost-minimizing behavior?
Obs y w w x x
A 100 2 1 10 20
B 110 1 2 14 10
1

## According to the WACM (Weak Axiom of Cost Minimization) we

must have that:
The cost of the observed choice of inputs is no greater than the
cost of any any other level of inputs that would produce at least as
much output.
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Prot Function
Cost minimization

Exercise
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Exercise

4.3
4.4
4.6
4.7
4.8

Solution

## In our case to produce 100 units of output it costs 40

(10 2 + 20 1) while
to produce 110 units of output it costs 34 (14 1 + 2 10)
The data violate WACM

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Prot Function
Cost minimization

Exercise
Exercise
Exercise
Exercise
Exercise

4.3
4.4
4.6
4.7
4.8

Outline
1

Prot Function
Exercise 3.1
Exercise 3.2
Exercise 3.3
Exercise 3.4
Exercise 3.5
Cost minimization
Exercise 4.3
Exercise 4.4
Exercise 4.6
Exercise 4.7
Exercise 4.8
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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Exercise 4.8

## A rm has a production function y = x x . If the minimum cost of

production at w = w = 1 is equal to 4, what is y equal to?
1

min x + x
1

s .t . x x
1

=y

## and by using the constraint you obtain:

min x + y /x
1

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Exercise
Exercise
Exercise
Exercise
Exercise

Prot Function
Cost minimization

4.3
4.4
4.6
4.7
4.8

Solution

We have that:

y =4=x

+ x2 = 2

and nally:

y =4

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