Technology PDF

Technology
Prot maximization
Exercises of Microeconomics
Technology and Prot Maximization (Ch. 1-2 Varian)
Fabio Tramontana (University of Pavia)
slides available at: http://tramontana.altervista.org/teaching.html
PhD in Economics at L.A.S.E.R.
Tramontana Exercises Micro

Technology
Prot maximization
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Technology Exercise 1.3
Prot maximization Exercise 1.5
Exercise 1.9
Exercise 1.11
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.2
What is the elasticity of substitution for the general CES

technology y = a x + a x when a 6= a ?
/ 1
1 1 2 2 1 2
Let us start by recalling that the elesticity of substitution measures

the curvature of an isoquant and can be calculated as:
TRS d (x /x ) 2 1
=
(x /x ) dTRS
2 1
or, by using the logarithmic derivative:
d ln(x /x )
2 1
=
d ln |TRS |
Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
We rst need to calculate the technical rate of substitution (TRS).

Remember that:
f / x1
TRS =
f / x2
in our case:
1
f 1 1
= ax
+ a2 x2

a x 1
for i = 1, 2
xi
1 1 i i
from which:
a x
!1
TRS = 1 1
a 2 x 2

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
so that:
1
x2 a2 1

= TRS

x1 a1
and taking logs:
x 1 a
!
ln ln |TRS | + ln
2 2
= ,
x1 1 a 1
and we can apply the denition:
d ln(x /x )
2 1 1
= = .
d ln |TRS | 1
Exercise 1.2
Exercise 1.9
Exercise 1.11
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.3
Dene the output elasticity of a factor i to be

f (x) xi
i (x ) =
xi f (x)
If f (x) = x x , what is the output elasticity of each factor?

a
1
b
2
Let us rst calculate the partial derivative of the production

function with respect to the factor x : 1
f (x)
= ax1a1 x2b
x1

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
from which we have that:

f (x) x1 ax x a b
1 (x ) = = 1 2
=a
x1 f (x) xx a
1
b
2
and with a similar reasoning:
f (x) x2 bx x a b
2 (x ) = = 1 2
= b.
x2 f (x) xx a
1
b
2

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
Note that the same elasticity can be calculated through the

following alternative denition:
d ln f (x)
i (x ) =
d ln x i
In our case we have that:

ln f (x ) = ln x x = ln x + ln x
a
1
b
2 1
a b
2
that is
ln f (x ) = a ln x + b ln x
1 2
and nally:
d ln f (x) d ln f (x)
1 (x ) = =a ; 2 (x ) = =b .
d ln x1 d ln x 2

Exercise 1.2
Exercise 1.9
Exercise 1.11
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.5
What is the elasticity of scale of the CES technology x + x

1/
1 2
?
Let us start by recalling that the elesticity of scale is dened as:
dy (t ) t

e (x) =
dt y =t 1
or:
df (t x) t

e (x) =
dt f (t x) = t 1

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
For the CES function we have that:

f (t x) = (tx ) + (tx2 ) =t x + x
1/ 1/
1 1 2
that is:
f (t x) = tf (x).
The CES function exhibits constant returns to scale.
In particular:
df (t x) t dtf (x) t

e (x) = = = 1.
dt f (t x) = t 1
dt tf (x) = t 1

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
Again, we should obtain the same result by using logarithms.

The elasticity of scale can be written as:
d ln f (t x)

e (x) =
d ln t = t 1
In our case:
1
ln f (tx ) = ln t + ln x + x

1 2

so:
e (x) = 1.

Exercise 1.2
Exercise 1.9
Exercise 1.11
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.9
Consider the CES technology f (x , x ) = a x + a x . Show

1/
1 2 1 1 2 2
that we can always

write this in the form
f (x , x ) = A() bx + (1 b)x
1 2 1
/
2
. 1
We need to use some algebraic trick in order to solve the problem.

a + a2
Let us multiply the parameters a and a by = 1:
1
1 2
a 1 + a2
# 1
(a + a )a (a + a )a
"
f (x1 , x2 ) = 1 2 1 x1 + 1 2 2 x2 .
a1 + a2 a1 + a2

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
Now we can write:

# 1
a a
"
1
f (x , x ) = (a1 + a2 )
1
x + 2
x
1 2
a 1 + a2 1
a 1 + a2 2
a a
and by noting that = 1 we can nally have:
2 1
a 1 + a2 a 1 + a2
f (x , x ) = A() bx + (1 b)x
1/
1 2 1 2
1 a
where A() = (a + a ) and b = .
1
1 2
a +a 1 2

Exercise 1.2
Exercise 1.9
Exercise 1.11
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.11
For each input requirement set determine if it is regular, monotonic

and/or convex. Assume that the parameters a and b and the
output levels are strictly positive.
Remember that a input requirement set is regular provided that

V (y ):
closed (it must include its own boundary)
non-empty (each positive level of output can be produced)

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.11 (a)
(a) V (y ) = {x , x : ax log y , bx log y }

1 2 1 2
This is a case in which the isoquants look like the isoquants of the
Leontief technology.
The main dierence is that output is measured in terms of log y :

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
As for the Leontie technology, V (y ) is closed, non-empty

(regular), monotonic and convex.

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.11 (b)
(b) V (y ) = {x , x : ax + bx y , x > 0}
1 2 1 2 1
In this case the isoquants have the following shape:

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
It follows that V (y ) is non-empty but not closed, so it is not

regular.
In fact:
you can produce the quantity y with combinations of inputs in
which x is arbitrarily low, but not equal to 0. So the input
1
requirement set does not contain one of its boundaries.

V (y ) is also monotonic and convex.

Exercise 1.2
Exercise 1.9
Exercise 1.11
Exercise 1.11 (c)

(c) V (y ) = x , x : ax + x x + bx y

1 2 1 1 2 2
It is immediate to see that in this case V (y ) is regular.

In order to prove monotonicity we must calculate the rst
derivatives:
f (x1 ,x2 )
x1 = a + 2xx21 x2 0
f (x1 ,x2 )
x2 = b + 2xx11 x2 0
so V (y ) is monotonic.

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
To prove that the isoquants are convex, it is sucient (but not

necessary) to show that the production function is concave.
We need to calculate the Hessian matrix, so we need the second
derivatives:
32 1 1 1
f (x1 ,x2 )
x12
= 14 x1 x2
2
f (x1 ,x2 )
x1 x2 = x2 x2
1
4 1 2
12 12 1 3
f (x1 ,x2 )
x1 x2 = 1
4
x x
1 2
f (x1 ,x2 )
x22
= x2x 2
1
4 1 2
that are the elements of the Hessian matrix.

Exercise 1.2
Exercise 1.9
Exercise 1.11
Solution
The principal minors are:

3 1
D 1 = 14 x1 2 x22 < 0
D 2 = 16 x1
1
x2 161 x11 x21 = 0
1 1
so the Hessian matrix is semi-denite negative, the production

function is concave and the input requirement set is convex.

Exercise 2.3
Exercise 2.7
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 2.3
Exercise 2.7
Exercise 2.3
Calculate explicitly the prot function for the technology y = x , for

a
0 < a < 1 and verify that it is homogeneous and convex in (p , w ).
We know (also from the Example in the text) that the rst-oder
condition is given by:
pax a 1
= w,
while the second-order condition is satised when a 1.
By expliciting x we obtain the factor demand function:
1
w a1
!
x (p , w ) =
ap

Exercise 2.3
Exercise 2.7
Solution
The supply function is obtained by putting the factor demand

function into the production function:
a
w a1
!
y (p, w ) = f (x (p, w )) = ,
ap
from which we nally have the prot function:
a 1
w a1 w a1
! !
(p , w ) = py (p , w ) wx (p , w ) = p w .
ap ap
Exercise 2.3
Exercise 2.7
Solution
Let us prove homogeneity:
a 1
w a1 w a1
! !
(tp , tw ) = tp tw = t (p , w ),
ap ap
then the prot function is homogeneous of degree 1.
In order to prove convexity, it remains useful to see the prot
function as follows:
1 a a 1 1 a
(p , w ) = p 1a w a1 a 1a a 1a = p 1a w a1 (a),

with (a) is strictly positive, provided that 0 < a < 1.

Exercise 2.3
Exercise 2.7
Solution
The Hessian matrix is dened as:

2 (p , w ) 2 (p , w )

D 2 (p, w ) =
p2 p w
(p , w ) (p , w )

2 2
wp w2
that in our case is:

2a1 a a 1
p 1a w a1 (1aa)2 p 1a w a1
!
a
(1a)2
= a 1 1 2a (a),
( )2 p 1a w a1
1
a
a
a
(1a)2
p 1a w a1

Exercise 2.3
Exercise 2.7
Solution
whose principal minors are:

2a1 a
1 = a
(1a)2
p 1a w a1 (a) > 0 , 2 = 0 .
So, the Hessian matrix is a positive semidenite matrix and:

(p , w ) is convex in (p , w ).

Exercise 2.3
Exercise 2.7
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 2.3
Exercise 2.7
Exercise 2.4
Let f (x , x ) be a production function with two factors and let w

1 2 1
and w be their respective prices. Show that the elasticity of the

2
factor share (w x /w x ) with respect to (x /x ) is given by

2 2 1 1 1 2
1/ 1.
Let us note that in logarithms the mentioned elasticity is calculable

as follows:
d ln(w x /w x ) 2 2 1 1
,
d ln(x /x ) 1 2
but by using the properties of logarithms we have that:

ln(w x /w x ) = [ln(w /w ) + ln(x /x )] .
2 2 1 1 1 2 1 2

Exercise 2.3
Exercise 2.7
Solution
Therefore,
d ln(w x /w x ) d ln(w /w )
1.
2 2 1 1 1 2
=
d ln(x /x ) 1 2 d ln(x /x )2 1
Now, from the prot maximization condition we obtain that:

f
w
|TRS | = x1 1
= ,
f
x2
w 2
so the formula of the elasticity can be written as:
d ln(w /w ) d ln |TRS |
1 = 1
1 2
d ln(x /x )
2 d ln(x /x )
1 2 1

Exercise 2.3
Exercise 2.7
Solution
d ln |TRS |
but is the inverse of the elasticity of substitution , so
d ln(x /x )
1 2
nally we have that the required elasticity is given by:
1
1


Exercise 2.3
Exercise 2.7
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 2.3
Exercise 2.7
Exercise 2.5
Show that the elasticity of the factor share with respect to (w /w ) 2 1
is 1 .
The elasticty of the factor share with respect to (w /w ) can be 2 1
calculated as follows:
d ln(w x /w x
2 2 1 1 )
.
d ln(w /w )
2 1
From Exercise 2.4 we know that:

ln(w x /w x ) = [ln(w /w ) + ln(x /x )] ,
2 2 1 1 2 1 2 1

Exercise 2.3
Exercise 2.7
Solution
so we have that:
d ln(w x /w x ) d [ln(w /w ) + ln(x /x )] d ln(x /x )
= 1
2 2 1 1 2 1 2 1 2 1
= ,
d ln(w /w )
2 1 d ln(w /w ) 2 1 d ln |TRS |
and nally:
d ln(w x /w x )
= 1.
2 2 1 1
d ln(w /w )
2 1

Exercise 2.3
Exercise 2.7
Outline
1 Technology
Exercise 1.2
Exercise 1.3
Exercise 1.5
Exercise 1.9
Exercise 1.11
2 Prot maximization
Exercise 2.3
Exercise 2.4
Exercise 2.5
Exercise 2.7

Exercise 2.3
Exercise 2.7
Exercise 2.7 (a)
The production function is f (x ) = 20x x and the price of output

2
is normalized to 1. Let w be the price of the x input. We must

have x 0.
(a) What is the rst-order condition for prot maximization if
x > 0?
We know that:
(x ) = f (x ) wx = 20x x 2 wx
from which we obtain the rst-order condition:
0 (x ) = 20 2x w = 0.

Exercise 2.3
Exercise 2.7
Exercise 2.7 (b)
(b) For what values of w will the optimal x be zero?
From the previous point we know that the optimal level of input is
given by:
20 w
x =
2
which is equal to zero provied that:
w = 20
but also if w > 20, in fact the input level cannot be negative.

Exercise 2.3
Exercise 2.7
Exercise 2.7 (c)
(c) For what values of w will the optimal x be 10?
We must solve:
20 w
x = = 10
2
from which:
w = 0.

Exercise 2.3
Exercise 2.7
Exercise 2.7 (d)
(d) What is the factor demand function?
The factor demand function comes from the rst-order condition by

expliciting x :
20 w w
x= = 10
2 2
but given the physical restriction concerning the non-negativity of
the input's level we should write:
x = max {10 w /2, 0} .

Exercise 2.3
Exercise 2.7
Exercise 2.7 (e)
(e) What is the prot function?
The prot function is a function of prices.

Until now we have:
(x , w ) = 20x x 2 wx = (20 w x )x
but now we can use the optimal level of input to obtain:
w
!2
(w ) = 10 .
2

Exercise 2.3
Exercise 2.7
Exercise 2.7 (f)
(f) What is the derivative of the prot function with respect to w ?
From the prot function obtained in the previous point we can

easily calculate the derivative:
w 1
! !
0 (w ) = 2 10
2 2
that is:
w
!
(w ) = 10
0
,
2
which is the negative of the factor demand, as we should expect.

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Technology

Fabio Tramontana (University of Pavia)

slides available at: http://tramontana.altervista.org/teaching.html

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

Tramontana Exercises Micro

Tramontana Exercises Micro

Tramontana Exercises Micro

What is the elasticity of substitution for the general CES

Let us start by recalling that the elesticity of substitution measures

or, by using the logarithmic derivative:

We rst need to calculate the technical rate of substitution (TRS).

Tramontana Exercises Micro

and we can apply the denition:

Tramontana Exercises Micro

Dene the output elasticity of a factor i to be

If f (x) = x x , what is the output elasticity of each factor?

Let us rst calculate the partial derivative of the production

Tramontana Exercises Micro

from which we have that:

and with a similar reasoning:

Tramontana Exercises Micro

Note that the same elasticity can be calculated through the

In our case we have that:

Tramontana Exercises Micro

Tramontana Exercises Micro

What is the elasticity of scale of the CES technology x + x

Let us start by recalling that the elesticity of scale is dened as:

Tramontana Exercises Micro

For the CES function we have that:

Tramontana Exercises Micro

Again, we should obtain the same result by using logarithms.

Tramontana Exercises Micro

Tramontana Exercises Micro

Consider the CES technology f (x , x ) = a x + a x . Show

that we can always

We need to use some algebraic trick in order to solve the problem.

Tramontana Exercises Micro

Now we can write:

Tramontana Exercises Micro

Tramontana Exercises Micro

For each input requirement set determine if it is regular, monotonic

Remember that a input requirement set is regular provided that

Tramontana Exercises Micro

Exercise 1.11 (a)

(a) V (y ) = {x , x : ax log y , bx log y }

Tramontana Exercises Micro

As for the Leontie technology, V (y ) is closed, non-empty

Tramontana Exercises Micro

Exercise 1.11 (b)

In this case the isoquants have the following shape:

Tramontana Exercises Micro

It follows that V (y ) is non-empty but not closed, so it is not

requirement set does not contain one of its boundaries.

Tramontana Exercises Micro

Exercise 1.11 (c)

It is immediate to see that in this case V (y ) is regular.

Tramontana Exercises Micro

To prove that the isoquants are convex, it is sucient (but not

that are the elements of the Hessian matrix.

Tramontana Exercises Micro

The principal minors are:

so the Hessian matrix is semi-denite negative, the production

Tramontana Exercises Micro

We rst need to calculate the technical rate of substitution (TRS).

and we can apply the denition:

Dene the output elasticity of a factor i to be

Let us rst calculate the partial derivative of the production

Let us start by recalling that the elesticity of scale is dened as:

As for the Leontie technology, V (y ) is closed, non-empty

To prove that the isoquants are convex, it is sucient (but not

so the Hessian matrix is semi-denite negative, the production

Calculate explicitly the prot function for the technology y = x , for

The Hessian matrix is dened as:

So, the Hessian matrix is a positive semidenite matrix and:

Now, from the prot maximization condition we obtain that:

nally we have that the required elasticity is given by:

from which we obtain the rst-order condition:

The factor demand function comes from the rst-order condition by

(e) What is the prot function?

The prot function is a function of prices.

(f) What is the derivative of the prot function with respect to w ?

From the prot function obtained in the previous point we can